Public Storage
Annual Report 1996

Plain-text annual report

Public Storage, Inc. 1996 Annual Report 2 th5Anniversary Total Revenues In Millions Net Income In Millions Funds From Operations Allocable To Common Shareholders In Millions $360 260 160 60 $160 120 80 40 0 $160 120 80 40 0 1994 1995 1996 1994 1995 1996 1994 1995 1996 Funds From Operations Per Fully Diluted Common Share(1) Annual Realized Rent Per Square Foot Same Store Facilities(1) Stock Price Performance Graph(1) Comparison of Cumulative Total Return Public Storage, Inc., S&P 500 Index and NAREIT Equity Index December 31, 1991 – December 31, 1996 $2.00 1.75 1.50 1.25 $8.80 8.60 8.40 8.20 8.00 1994 1995 1996 1994 1995 1996 $500 400 300 200 100 0 12/31/91 12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 Public Storage, Inc. S&P 500 NAREIT Equity $100.00 $100.00 $100.00 $117.80 $107.62 $114.59 $201.84 $118.46 $137.11 $215.57 $120.03 $141.46 $299.36 $165.13 $163.06 $507.39 $203.05 $220.56 (1) Assumes the conversion of the (1) “Same Store” refers to mini- (1) The graph compares the yearly change in the Company’s Company’s Convertible Preferred Stock into common stock. warehouses in which the Company had an interest since January 1, 1993. cumulative total shareholder return on its common stock for the five-year period ended December 31, 1996 to the cumula- tive total return of the Standard and Poor’s 500 Stock Index (“S&P 500 Index”) and the National Association of Real Estate Investment Trusts Equity Index (“NAREIT Equity Index”) for the same period (total shareholder return equals price appreciation plus dividends). The stock price performance graph assumes that the value of the investment in the Company’s common stock and each index was $100 on December 31, 1991 and that all dividends were reinvested. The stock price performance shown in the graph is not necessarily indicative of future price performance. P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Selected Financial Highlights (In thousands, except per share data) For the year ended December 31, R E V E N U E S : Rental income Equity in earnings of real estate entities Facility management fees Ancillary business income Interest and other income E X P E N S E S : Cost of operations Cost of facility management Cost of operations – ancillary business Depreciation and amortization General and administrative Interest expense Environmental cost Advisory fee Income before minority interest and gain on disposition of real estate Minority interest in income Income before gain on disposition of real estate Gain on disposition of real estate, net 1996(1) 1995(1) 1994 1993 1992 $ 294,005 22,121 14,428 3,504 7,064 $ 202,134 3,763 2,144 112 4,497 341,122 212,650 $ 141,845 764 – – 4,587 147,196 $ 109,203 563 – – 4,914 114,680 $ 95,886 – – – 1,562 97,448 93,244 2,575 3,418 64,967 5,524 8,482 – – 72,247 352 100 40,760 3,982 8,508 2,741 6,437 178,210 135,127 162,912 (9,363) 153,549 – 77,523 (7,137) 70,386 – 52,816 – – 28,274 2,631 6,893 – 4,983 95,597 51,599 (9,481) 42,118 – 42,116 – – 24,998 2,541 6,079 – 3,619 79,353 35,327 (7,291) 28,036 – 38,348 – – 22,405 2,629 9,834 – 2,612 75,828 21,620 (6,895) 14,725 398 Net income $ 153,549 $ 70,386 $ 42,118 $ 28,036 $ 15,123 P E R C O M M O N S H A R E : Income before gain on disposition of real estate Gain on disposition of real estate Net income Distributions per common share Weighted average common shares Total assets Total debt Minority interest Shareholders’ equity O T H E R D A T A : Net cash provided by operating activities Net cash used in investing activities Net cash provided by (used in) financing activities Funds from operations(2) $1.10 – $1.10 $0.88 $0.95 – $0.95 $0.88 77,358 41,171 $2,572,152 $ 108,443 $ 116,805 $2,305,437 $1,937,461 $ 158,052 $ 112,373 $1,634,503 $1.05 – $1.05 $0.85 24,077 $ 820,309 $ 77,235 $ 141,227 $ 587,786 $0.98 – $0.98 $0.84 17,558 $ 666,133 $ 84,076 $ 193,712 $ 376,066 $ 245,237 $ 123,466 $ 79,180 $ 59,477 $ (479,626) $ (248,672) $(169,590) $(137,429) $ 180,809 $ 185,491 $ 224,384 $ 105,086 $ 100,029 $ 56,143 $ 80,100 $ 35,830 $0.88 0.02 $0.90 $0.84 15,981 $537,724 $ 69,478 $202,797 $253,669 $ 44,025 $ (21,010) $ (21,010) $ 21,133 (1) During 1996 and 1995 the Company completed several significant business combinations and equity transactions. See Notes 3 and 11 to the Company’s consolidated financial statements. (2) Funds from operations (“FFO”), means net income (loss) (computed in accordance with GAAP) before (i) gain (loss) on early extinguishment of debt, (ii) minority interest in income and (iii) gain (loss) on disposition of real estate, adjusted as follows: (i) plus depreciation and amortization (including the Company’s pro-rata share of depreciation and amortization of unconsolidated equity interests and amortization of assets acquired in the PSMI Merger, including property manage- ment agreements and excess purchase cost over net assets acquired), and (ii) less FFO attributable to minority interest. FFO is a supplemental performance measure for equity REITs as defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”). The NAREIT definition does not specifically address the treatment of minority interest in the determination of FFO or the treatment of the amortization of property management agreements and excess purchase cost over net assets acquired. In the case of the Company, FFO represents amounts attributable to its shareholders after deducting amounts attributable to the minority interests and before deductions for the amortization of property management agreements and excess purchase cost over net assets acquired. FFO is presented because many analysts consider FFO to be one measure of the performance of the Company and it is used in certain aspects of the terms of the Class B Common Stock. FFO does not take into consideration scheduled principal payments on debt, capital improvements distributions and other obligations of the Company. Accordingly, FFO is not a substitute for the Company’s cash flow or net income as a measure of the Company’s liquidity or operating performance or ability to pay distributions. 1 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T In Memoriam Kenneth Q. Volk, Jr. Co-founder and Chairman Emeritus August 14, 1918 – June 3, 1996 He had the rare vision and talent to nearly single-handedly create an entire industry. We will miss his quiet and dignified leadership. To Our Shareholders For the last 25 years Public Storage, Inc. has successfully provided self- storage solutions to a wide-range of Americans. We have grown and adapted in response to the changing needs of our cus- tomers. The theme of this year’s annual report is how we are adding value for both our shareholders and our customers. We are adding value for shareholders by: • Diversifying our self-storage operations with complementary businesses • Utilizing retained cash flow for property acquisition and development • Increasing funds from operations and cash available for distributions • Leveraging our competitive strengths Our customers are the engine that propel our enterprise. We are adding value to the self-storage experience for our 540,000 tenants by: • Augmenting and improving the inter- action between Public Storage and our customers • Offering competitive pricing structures • Providing professionally managed, clean, quality self-storage space in met- ropolitan markets • Enhancing our property operations through new marketing mechanisms, systems and controls, and property repackaging programs This letter will explain how and why we now see Public Storage as an umbrella under which four closely related business lines fit, the mechanisms through which we are promoting our established and developing business segments, our distinct competitive attributes, and our future plans. A F U L L Y I N T E G R A T E D C O M P A N Y Public Storage is a diversified, nationwide enterprise possessing a strong operating bus- iness coupled with strong and flexible finan- cial resources. In tandem, these strengths result in an organization that generates rising funds from operations and reinvests a sub- stantial portion of its cash flows generated from operations. We use our established core operating business, solid financial strength, size and national presence, and trade name to support distinct, yet interrelated, existing and emerging lines of business. Along with our established core business, these comple- mentary activities of our subsidiaries are designed to generate consumer demand for portable self-storage space, truck rentals, and purchase of move-related merchandise. Public Storage Pickup & Delivery,SM Truck Rentals, and Retail Stores are a logical 2 extension of our core activity – owning and operating self-storage properties in major metropolitan markets throughout the United States. We can, for example, respond to cross-marketing opportunities with our self- storage properties at the nucleus of our services. Our national call reservation center contributes to our ability to offer “one-stop- shop” convenience. Indeed, a goal of our national call reservation center is to provide customers with a single point of contact for all their storage-related needs. We look at it as smart business. For our customers, it is as easy as calling one of our properties or our national toll-free number. Public Storage offers the benefits of professional management, diversification, current income, infinite life and liquidity. However, we believe Public Storage has moved beyond the traditional expectation of real estate investment trusts as being primarily passive real estate portfolios. Specifically, we operate like a traditional operating company within the structure of a real estate investment trust. Public Storage is self-administered and self-managed. We have expertise in real estate development, construction, acquisition, operations and leasing services. We are fully involved in our self-storage, portable self-storage, truck rentals, and retail stores businesses. We believe that our multiple business line infra- structure adds value to Public Storage for shareholders and our customers. We use our retained operating cash as an internal source of capital for property acqui- sition, development and debt reduction. Approximately $71 million of funds from operations were retained in 1996 and we expect to retain approximately $100 million in 1997. We believe cash retention enhances Public Storage’s value and anticipate contin- uing this long-term goal. R E A L I Z I N G B E N E F I T S O F T H E 19 9 5 M E R G E R The major merger on November 16, 1995 consolidating Storage Equities, Inc. and Public Storage, Inc. helped position us for growth in 1996. It enhanced our competitive position and made Public Storage’s structure more efficient. The merger produced a com- pany of substantial size and diversification. Based on capitalized market value, we are now one of the largest real estate investment trusts in the United States. We own and oper- ate more self-storage space than any of our competitors. As a direct result of the merger, the three major credit rating agencies P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T upgraded our credit rating, reducing our cost of new capital. The merger significantly reduced internal conflicts inherent in the separate advisor/property manager format. Institutional investor interest in our corpora- tion has improved. We believe we experi- enced numerous positives from the merger throughout 1996 and expect this direction to be maintained in the future. C A P I T A L I Z I N G O N E S T A B L I S H E D C O M P E T I T I V E S T R E N G T H S We believe that Public Storage possesses strengths which are difficult for our competi- tors to reproduce. These include: • Strong operating business • Financial strength • Trade name • Market share • Geographic diversification • Management Strong operating business. Funds from operations (FFO) per common share is con- sidered a key measure of the performance of Public Storage. FFO per common share advanced 14 percent, from $1.73 per share for the year ended December 31, 1995, to $1.98 per share for the year ended December 31, 1996. We are adding to shareholder value by practicing a conservative approach to distri- butions. Retaining a substantial portion of funds from operations (after funding Public Storage’s distributions and capital improve- ments) enables us to acquire and develop properties and reduce debt using internal cash resources. In this regard, Public Storage differs significantly from its competitors, a difference we believe is a favorable factor in our long-term business plans. We distributed 44 percent of FFO per common share for 1996 and 52 percent for 1995. Through our relatively moderate payout ratio in 1996 we retained $71 million of free capital to purchase and develop properties. Occupancy levels have historically repre- sented one of the simplest but most efficient windows into the strength and success of our business. They show the balance between the The industry’s most enduring icon. forces of supply and demand and the effects of our promotional activities. For the year ended December 31, 1996, occupancy at the self-storage properties on a Same Store basis averaged 91.2 percent, compared to 90.1 percent one year earlier. Same Stores are the 951 mini-warehouses that Public Storage has had an interest in since January 1, 1993. The amount of rent Public Storage collects bears an important connection to occupancy trends. To the extent feasible we try to generate rising or high occupancy levels and rising rental rates. Same Store average annual realized rent represents the actual revenue earned per occupied square foot and is a more relevant measure than posted rental rates. Same Store average annual realized rent was $8.76 per square foot for the year ended December 31, 1996, com- pared to $8.40 per square foot for the same period of 1995, an increase of 4.3 percent. Same Store revenues equaled $445.6 million for the year ended December 31, 1996, com- pared to $422.9 million for the same period one year earlier, an increase of 5.4 percent. Financial strength. We have a strong bal- ance sheet. Total assets, total debt, and total shareholders’ equity are barometers of our balance sheet strength. As of December 31, 1996, Public Storage’s assets totaled approx- imately $2.6 billion, a $635 million increase from approximately $1.9 billion one year earlier. Public Storage’s debt-to-equity ratio was reduced from approximately 10 per- cent at December 31, 1995 to 5 percent at December 31, 1996. Low debt leverage in conjunction with our access to capital should position us to respond to investment oppor- tunities in our industry. Shareholders’ equity equaled $2.3 billion as of December 31, 1996, approximately 41 percent greater than the $1.6 billion reported one year earlier. Public Storage’s common stock achieved all-time highs during 1996. Public Storage responded to its strong financial position dur- ing 1996 by completing two separate pre- ferred stock offerings, raising $260 million, and two common stock offerings, raising approximately $129 million. In March 1997, Public Storage com- pleted a common stock offering that raised approximately $127 million. Since January 1, 1993, Public Storage has issued approximately $1.022 billion of equity capital, the proceeds of which were used to reduce debt and acquire interests in self-storage properties. 3 Stock Performance(1) The value of the Company’s common stock has increased, reflecting in part growth opportunities in the Company’s business. STOCK PRICE RANGE Low High 1996 1st quarter 2nd quarter 3rd quarter 4th quarter 1995 1st quarter 2nd quarter 3rd quarter 4th quarter $217⁄8 211⁄2 225⁄8 313⁄8 $171⁄8 171⁄8 183⁄4 193⁄4 $187⁄8 193⁄8 197⁄8 221⁄4 $131⁄2 151⁄4 163⁄8 173⁄8 Close $203⁄8 205⁄8 225⁄8 31 $17 163⁄8 185⁄8 19 (1) The common stock has been listed on the New York Stock Exchange since October 19, 1984. The ticker symbol is PSA. Public Storage completed eight merger transactions with affiliates in 1996, acquiring 105 properties. In December 1996, Public Storage and two affiliates, Public Storage Properties XIV, Inc., and Public Storage Properties XV, Inc., agreed, subject to certain conditions, to merge. Requirements for the mergers include the approval by the shareholders of each of the affiliates. If approved, the mergers are expected to be completed during the first half of 1997. These affiliates collectively own 31 self-storage properties and two business parks. Public Storage currently owns about one-third of the capital stock of each of these affiliates and manages the properties. We are continuing to evaluate transactions with other affiliates whose properties are man- aged by Public Storage. From January 1, 1994 through Decem- ber 31, 1996, Public Storage acquired, in cash tender offers, limited partnership inter- ests in partnerships of which Public Storage is a general partner for an aggregate pur- chase price of approximately $86 million. These acquisitions are intended to reduce minority interest in the long-term and increase Public Storage’s ownership interest in its current property portfolio. Trade name. Public Storage’s 1,064 self- storage or self-storage/ business park combi- nations operate under the most recognized trade name in the self-storage industry. We believe that this enables us to provide conti- nuity from one rental experience to the next, customers being able to expect the same level of quality and professionalism regard- less of which Public Storage property they P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T choose to rent or which of our other storage-related ser- vices they choose to use. Market share. By concentrating our properties in or near major metropolitan areas we can take advantage of market share and economies of scale. Indeed, clus- tering our properties around a common economic focal point allows for the cost effective distri- bution of marketing expenditures, economies of scale, and manage- ment supervision. These factors contribute to our properties’ oper- ating margins. Additionally, operat- ing numerous properties in a market helps our national reservation center maximize its capacity to effectively shop space for cus- tomers, simplifying their search for the exact size, location, and price. Geographic diversification. Our sizeable portfolio is geographically diversified, pro- viding additional competitive advantages. No single self-storage property accounts for more than one percent of revenues. We also believe that we can generate more stable cash flows because a large, diversified portfolio can better absorb local economic downturns. Management. Another strength of Public Storage is the substantial experience and expertise of our senior officers. They have significant operating and financial experi- ence. They have been responsible for the acquisition of more than 350 self-storage properties, the development of more than 650 self-storage properties and the man- agement of more than 1,000 self-storage properties over the last 25 years. We also benefit from our efficient property manage- ment team. They use systems and controls, performance standards, and operating procedures to effectively manage the day- to-day demands of our enterprise. The property management division is comprised of approximately 2,800 personnel. A continuing objective of our management system is to cultivate a customer base which is satisfied with our product and services. D E V E L O P I N G N E W C O M P E T I T I V E S T R E N G T H S We are developing new ways to market our self-storage properties, portable self-storage, truck rentals and retail stores, to enhance the visual appeal of our properties, to improve how customers locate a Public Storage property and how we manage our a property through our directory ads. We have an internal Yellow Pages agency. Visual repackaging. Many of our properties have now had their appearance improved to augment their competitiveness in an increas- ingly cluttered visual landscape. Modernizing the look of the old orange and black “Ps” logo and facility signage should also add to the customer-friendliness of our image and convey the cutting-edge nature of our approach to property management. Reaction to our new orange and plum logo and signage has been favorable. The program should also help promote consistency in appearance from property to property. We added to the value of our properties by investing about $6 million in 1996 with this program and expect to invest approximately that amount in 1997. Systems and controls.Last year we began to update and expand the software used in our computerized property management system. The system, installed at each of our properties, transmits and receives data regarding unit availability, delinquencies, accounting and cash management. We enhanced the software package to allow us to track the sales activity of all the merchandise products and to monitor the effectiveness of our national reservation center. The Internet. The number of hits our user-friendly home page receives is steadily growing. Customers can complete rental applications through our Internet site. We use our national reservation center to follow-up on rental applications received through the Internet. We expanded our investor service function on our home page, providing alter- native methods for shareholders to commu- nicate with us and with Public Storage’s transfer agent. We are exploring additional ways to benefit from the Internet. Our Internet address is http://www.publicstorage.com. We welcome your suggestions or comments. F U T U R E O P P O R T U N I T I E S During 1996 Public Storage continued to grow. However, not everything is clear sailing in the mini-warehouse industry and there could be a squall or two on the horizon. Supply and demand factors fluctuate, variables which are intensified by new construction activities. Supply/demand disequilibrium could result in negative trends in mini-warehouse occupancy levels and rental rates in affected markets. Nevertheless, we are optimistic that our com- The Public Storage Property System operations. These new activities encompass: • National reservation center • Directory advertising • Visual repackaging • Systems and controls • The Internet National reservation center. We designed the national reservation center to contribute to our competitive edge by continuously offer- ing our customers new and better services and products. We inaugurated the center in December 1995. At December 31, 1996, 87 representatives were on staff using an inte- grated telephone and computer system to access current information about space avail- ability and rates for the majority of Public Storage’s properties. A customer calling a property, or Public Storage’s national toll-free number (1-800-44-STORE), can be connected with the center. The center currently receives about 120,000 calls per month. We can mar- ket all of our business lines through the national reservation center. We believe that improving and expanding upon our ability to generate customer demand enables us to support favorable occupancy trends through the national reservation center. We believe that we alone offer a broad, technologically- advanced service such as this. Directory advertising. We are expanding the number of markets in which directory advertising is used and the number of direc- tories in which a Public Storage display ad appears. We are currently using Yellow Pages advertising in over 700 directories in 80 mar- kets. We are utilizing larger-sized ads to identify all the properties in a given market, and where appropriate are using ads for our portable self-storage business in tandem with ads for traditional self-storage space. Directory advertising is the most important of the print media in promoting our services since about one-third of our customers locate 4 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T petitive advantages will continue to attenuate the effects of these pressures. Our strengths include the significant operating and financial experience of our executive officers and directors, Public Storage’s strong operating business and financial strength, national investment scope, geographic diversification, economies of scale, and our trade name. In February 1997 we reached an agree- ment in principle with a joint venture partner to participate in funding the development of approximately $220 million of mini- warehouses (including the properties cur- rently under development by Public Storage). The joint venture partner would contribute about 70 percent of the venture’s capital with the balance provided by Public Storage. After a period of time, Public Storage would have an option to acquire the other venture partner’s interest. The construction of self- storage properties and the relatively long “fill-up” period to reach a stabilized occu- pancy level creates short-term earnings dilu- tion. We expect that the development joint venture will alleviate this earnings dilution. There can be no assurance that a definitive agreement can be reached between Public Storage and the joint venture partner. Assuming an agreement is finalized, it is expected that the joint venture would be funded in April 1997. As of December 31, 1996 we had five recently developed self-storage properties (costs of $23.5 million) open and in the fill- up stage. An additional 11 facilities were under construction (estimated costs of $56 million) with expected opening dates ranging from January 1997 through March 1998. Our investment strategy will continue to include developing mini-warehouses. Consequently, we have approved the develop- ment of an additional 17 facilities (estimated costs of $70.2 million) with construction and completion dates through mid-1998. We are currently evaluating the feasibility of devel- oping additional mini-warehouses in selected markets in which there are few, if any, facili- ties to acquire at attractive prices and where the scarcity of other undeveloped parcels of land or other impediments to development make it difficult to construct additional com- peting facilities. At the end of 1996 Public Storage and HFS Incorporated, the world’s largest franchisor of residential real estate brokerage offices, entered into a three-year preferred vendor agreement to co-market rental storage space to franchisees and customers of HFS Incorporated’s three real estate brands. The agreement provides certain pricing discounts on self-storage rental space for CENTURY 21,® Coldwell Banker,® and ERA® franchised brokerages and their customers. We should be able to use our national reser- vation center to offer these services to the clientele of some of the largest real estate brand names in the country. Last year we opened, on an experimental basis, complete storage-related retail centers at self-storage locations in Atlanta, Georgia and Southern California. We plan to continue opening retail stores in selected markets. Currently, we have 13 retail stores in opera- tion and 20 retail store conversions. If the previously discussed joint venture agreement is reached, all future development projects, including projects currently under construc- tion and development, will be presented to the joint venture for approval and acceptance into their portfolio. Public Storage will then Portfolio Growth 1980-1996 ) 6 9 / 1 3 / 2 1 h g u o r h t ( s t s e r e t n i y t r e p o r P 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 Years (through 12/31/96) have the option to construct any project not approved by the joint venture. Almost all newly constructed Public Storage self- storage properties will feature a retail oper- ation. The retail operations are performed through a subsidiary of the Company. In 1996 we organized Public Storage Pickup & DeliverySM (PSPUD) as a separate corporation to operate a portable self- storage business that rents storage contain- ers to customers for storage in central warehouses and provides related transporta- tion services. PSPUD currently operates a total of twelve facilities in six greater metro- politan areas in California and Texas. PSPUD anticipates opening four additional facilities 5 in these areas and in three additional metro- politan areas by the end of the first quarter of 1997. PSPUD presently anticipates expand- ing its operations to a significant number of additional areas during the remainder of 1997 and in 1998, subject to continuing eval- uation of the feasibility of this business and the satisfaction of regulatory requirements. There can be no assurance on the level of PSPUD’s expansion or profitability. M A I N TA I N I N G I N D U S T R Y L E A D E R S H I P We entered 1996 with substantial momentum from the merger that was consummated on November 16, 1995. That merger increased our competitive position and provided for a more efficient organizational structure. As we progressed through 1996 we enhanced the economic value of our business at the property level. We did this primarily by com- pleting financial transactions that improved our balance sheet, incorporating new infor- mation and operating technologies into our property management system, and expand- ing the complementary businesses that now constitute part of the Public Storage infrastructure. In evaluating how effectively we are accommodating our customers’ needs, we emphasize certain key elements: value, ser- vice, location, product, and marketing. To our 540,000 customers, adding value to their self-storage experience means maximizing the “what they receive” side of the equation while minimizing the “what they pay” side of the equation. We anticipate our shareholders will benefit from our long-term operating and investment strategies and our substantial strengths in 1997 and beyond, and we thank our shareholders for their continued support. Sincerely, B. Wayne Hughes Chairman of the Board and Chief Executive Officer Harvey Lenkin President March 31, 1997 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Under the Public Storage Umbrella Self Storage.We offered over half a million self-storage spaces, encompass- ing about sixty-four million net rentable square feet, to the market at the end of 1996. At December 31, 1996, we had direct and indirect equity inter- ests in 1,109 properties located in 38 states, including 1,064 self-storage facilities and 45 commercial properties. This level of market penetration, complemented by our property management system’s practice of operating properties in groups in major markets, provided competitive advantages to Public Storage last year. We believe Public Storage enjoys strengths which are difficult to imitate and, as such, are competitive advantages. These strengths include a strong operating business, size and national presence, trade name, and financial solidity. Our mini-warehouses are our primary real estate product. We plan to continue finding ways to ensure that we maintain our position as the preeminent provider of quality mini-warehouse space in major metropolitan markets in the United States. Container Storage. Public Storage Pickup & Delivery SM (PSPUD) is our newest complementary business activity. Customers of this service enjoy certain benefits. Customers do not need to rent a truck or unload their possessions. PSPUD delivers a storage container to the customer’s home or business. The container, made of wood, holds the items found in a typical living room. These containers feature remov- able center posts for easier access and locking hasps. Customers pack their items, lock the container and retain the key. We can provide any needed boxes and packing supplies. The customer takes as much time as needed to load the container. When finished, we will pick it up and transport it to our storage center. Customers can access their containers at any time during regular business hours at our storage center or we can deliver the container to their home or business. Truck Rentals.Our truck rental operation meets the public’s need for transportation of personal possessions. We currently have about 65 trucks available for rent in 45 locations. The trucks feature the amenities users demand, including automatic transmissions, low loading ramps, and air conditioning. Retail Stores.Retail stores address additional aspects of a customer’s relocation decision. Retail stores expand how Public Storage’s mini-warehouses accommodate customers’ needs. Tenants and other customers can purchase a variety of move- related merchandise, including corrugated boxes in a range of sizes, locks, packing supplies, and furniture covers. We are opening stores which are devoted primarily to selling these products, and have 13 so far. We have also converted 20 traditional mini-warehouses to offer enhanced retail products. Almost all newly constructed Public Storage mini-warehouses will feature a retail operation. 6 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Maximizing Competitive Strengths Sizeable, diversified customer base. At the end of 1996, 540,000 individuals and businesses comprised the Public Storage customer base. Our customers come from all walks of life. The majority of our customers can be categorized as commercial, residential, military and students. Since our customer base is broad, the Company avoids relying on a few major tenants or upon tenants in the same or similar business. Many of the Company’s properties are located in areas possessing growing populations and diversified economies, which often result in strong self-storage demand. Moving, home downsizing, marriage, divorce, job loss and attending college are some of the events that trigger an individual’s demand for self-storage space. Commercial users such as regional salesmen, small corporations and retailers use mini-warehouse properties to meet a multitude of record keeping and inventory storage needs. Enhancing our competitive edge. The national reservation center augments our competitive edge by continuously offering our customers new and better services and products. We can market mini-warehouses, container storage, truck rentals, retail stores, and our HFS preferred-vendor marketing arrangement to customers through the national reservation center. A customer calling a property, or our Company’s national toll-free number (1-800-44-STORE) can be connected with the center. The center currently receives about 120,000 calls per month. We plan to continue expanding the number of personnel staffing the reservation center and the product and services offered through it. We believe that improving and expanding upon our ability to increase customer demand has enabled us to support favorable occupancy trends through the national reservation center. Change stimulates self-storage demand. Part of the expanding need for storage space in many of the Company’s properties’ markets and across America is linked to economic and social changes, such as population movement. In fact, planned and unplanned relocation activity is one of the most important generators of self- storage demand: 46,000 American households relocate on any given day. Many of the Company’s properties are in locations that have about 100,000 people living in a five-mile marketing area around the property. The average city dweller moves every 7.5 years and will (according to the U.S. Postal Service) move 12 times in a lifetime. Accordingly, each year about 13,000 of the 100,000 people living within the market area of a typical Public Storage mini-warehouse may be seeking traditional or container self-storage and move-related supplies, a demand which the Company’s properties can accommodate. Simple construction/low costs yet high rental rates. Compare mini-warehouse construction costs to apartment costs and the resulting yield per square foot. The newly constructed Lake Forrest, California mini-warehouse featured throughout this annual report has an average per square foot rent of about $.92 a month. Surveys indicate a typical two bedroom apartment unit (approximately 1,000 square feet) in this property’s market area rents for about the same amount on a square foot basis. However, the costs to construct this mini-warehouse property were, on a square foot basis, significantly less. The 10¢ x 10¢ unit in the photo is essentially a simple box made of tilt-up concrete, corrugated steel and a reinforced roll up door. Mini-warehouses require a low level of capital expenditure to maintain their condition and appearance. Moreover, capital outlays are usually not required after a tenant vacates. Additionally, repricing risks are minimized since tenancy is usually less than one year, enabling revenues to parallel current market conditions. 7 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Consolidated Balance Sheets (In thousands, except per share data) For the year ended December 31, A S S E T S Cash and cash equivalents Real estate facilities, at cost: Land Buildings Accumulated depreciation Investment in real estate entities Intangible assets, net Mortgage notes receivable from affiliates Other assets Total assets L I A B I L I T I E S A N D S H A R E H O L D E R S ’ E Q U I T Y Notes payable Accrued and other liabilities Total liabilities Minority interest Commitments and contingencies S H A R E H O L D E R S ’ E Q U I T Y : Preferred Stock, $.01 par value, 50,000,000 shares authorized, 13,421,580 shares issued and outstanding (13,444,100 issued and outstanding at December 31, 1995), at liquidation preference: Cumulative Preferred Stock, issued in series Convertible Preferred Stock Common stock, $.10 par value, 200,000,000 shares authorized, 88,362,026 shares issued and outstanding (71,513,799 at December 31, 1995) Class B Common Stock, $.10 par value, 7,000,000 shares authorized and issued Paid-in capital Cumulative net income Cumulative distributions paid Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes. 8 1996 1995 $ 26,856 $ 80,436 596,141 1,625,172 2,221,313 382,144 1,030,990 1,413,134 (297,655) (241,966) 1,923,658 1,171,168 350,190 222,253 25,016 24,179 416,216 231,562 23,699 14,380 $2,572,152 $1,937,461 $ 108,443 $ 158,052 41,467 149,910 116,805 32,533 190,585 112,373 718,900 114,929 8,837 700 450,150 85,970 7,152 700 1,454,387 1,100,088 396,420 (388,736) 242,871 (252,428) 2,305,437 1,634,503 $2,572,152 $1,937,461 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Consolidated Statements of Income (In thousands, except per share data) For each of the three years in the period ended December 31, 1996 1996 1995 1994 $270,429 23,576 22,121 14,428 3,504 7,064 $184,100 18,034 3,763 2,144 112 4,497 341,122 212,650 82,494 10,750 2,575 3,418 64,967 5,524 8,482 – – 178,210 162,912 (9,363) 63,396 8,851 352 100 40,760 3,982 8,508 2,741 6,437 135,127 77,523 (7,137) $126,997 14,848 764 – – 4,587 147,196 45,266 7,550 – – 28,274 2,631 6,893 – 4,983 95,597 51,599 (9,481) $153,549 $ 70,386 $ 42,118 $ 68,599 84,950 $153,549 $ 31,124 39,262 $ 70,386 $ 16,846 25,272 $ 42,118 $ 1.10 77,358 $ 0.95 41,171 $ 1.05 24,077 R E V E N U E S : Rental income: Self-storage facilities Commercial properties Equity in earnings of real estate entities Facility management fee Ancillary business income Interest and other income E X P E N S E S : Cost of operations: Self-storage facilities Commercial properties Cost of facility management Cost of operations – ancillary business Depreciation and amortization General and administrative Interest expense Environmental cost Advisory fee Income before minority interest Minority interest in income Net income Net income allocation: Allocable to preferred shareholders Allocable to common shareholders P E R C O M M O N S H A R E : Net income Weighted average common shares outstanding See accompanying notes. 9 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Consolidated Statements of Shareholders’ Equity (In thousands, except share and per share amounts) For each of the three years in the period ended December 31, 1996 B A L A N C E S A T D E C E M B E R 3 1 , 19 9 3 Issuance of Preferred Stock, net of issuance costs: Series B, C and D (2,486,000 shares) Issuance of Common Stock (10,770,437 shares) Net income Cash distributions: Preferred Stock Common Stock, $0.85 per share B A L A N C E S A T D E C E M B E R 31, 19 9 4 Issuance of Preferred Stock, net of issuance costs: Series E, F, G (4,501,900 shares) Convertible Participating (31,200 shares) Issuance of Common Stock (42,687,092 shares) Issuance of Class B Common Stock (7,000,000 shares) Net income Cash distributions: Preferred Stock Common Stock, $0.88 per share B A L A N C E S A T D E C E M B E R 3 1, 19 9 5 Issuance of Preferred Stock, net of issuance costs: Series H and I (10,750 shares) Mandatory Convertible, Series CC (58,955 shares) Issuance of Common Stock (15,134,241 shares) Conversion of Mandatory Convertible Participating Preferred Stock into Common Stock (1,611,265 shares) Conversion of 8.25% Convertible Preferred Stock into Common Stock (102,721 shares) Net income Cash distributions: Preferred Stock Common Stock, $0.88 per share Preferred Stock Cumulative Convertible $103,125 $ 57,500 62,150 – – – – 165,275 284,875 – – – – – 450,150 268,750 – – – – – – – – – – – – 57,500 – 28,470 – – – – – 85,970 – 58,955 – (28,470) (1,526) – – – B A L A N C E S A T D E C E M B E R 31, 19 9 6 $718,900 $114,929 See accompanying notes. 10 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Paid-in Capital $ 227,891 (2,300) 146,770 – – – Cumulative Net Income $130,367 – – 42,118 – – Cumulative Distributions $(144,623) – – – (16,846) (21,249) 372,361 172,485 (182,718) (9,718) 664,645 72,800 – – – – – – 70,386 – – – – – – (31,124) (38,586) Total Shareholders’ Equity $ 376,066 59,850 147,847 42,118 (16,846) (21,249) 587,786 275,157 28,470 668,914 73,500 70,386 (31,124) (38,586) 1,100,088 242,871 (252,428) 1,634,503 (8,972) – 333,956 27,799 1,516 – – – – – – – – 153,549 – – – – – – – – (68,599) (67,709) 259,778 58,955 335,470 (510) – 153,549 (68,599) (67,709) Class B Common Stock $ – – – – – – – – – 700 – – – 700 – – – – – – – – Common Stock $1,806 – 1,077 – – – 2,883 – 4,269 – – – – 7,152 – – 1,514 161 10 – – – $8,837 $700 $1,454,387 $396,420 $(388,736) $2,305,437 11 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Consolidated Statements of Cash Flows (In thousands) For each of the three years in the period ended December 31, 1996 C A S H F L O W S F R O M O P E R A T I N G A C T I V I T I E S : 1996 1995 1994 Net income $ 153,549 $ 70,386 $ 42,118 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization (net of amortization of mortgage notes receivable discounts) Depreciation included in equity in earnings of real estate entities Environmental accrual (including $510 from equity in earnings of real estate entities) Minority interest in income Total adjustments Net cash provided by operating activities C A S H F L O W S F R O M I N V E S T I N G A C T I V I T I E S : Principal payments received on mortgage notes receivable Proceeds from disposition of real estate facilities, net Acquisition of minority interests in consolidated real estate partnerships Acquisition of mortgage notes receivable Acquisition of real estate facilities Acquisition cost of business combinations Acquisition of interests in real estate entities Construction in process Capital improvements to real estate facilities Net cash used in investing activities C A S H F L O W S F R O M F I N A N C I N G A C T I V I T I E S : Net paydowns on revolving line of credit Net proceeds from the issuances of preferred stock Net proceeds from the issuances of common stock Principal payments on mortgage notes payable Distributions paid to shareholders Distributions from operations to minority interests in consolidated real estate partnerships Net reinvestment by minority interests in consolidated real estate partnerships Other Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the year 64,875 17,450 – 9,363 91,688 245,237 1,784 – (15,419) (3,709) (198,404) (113,522) (83,893) (46,097) (20,366) 40,647 2,045 3,251 7,137 53,080 123,466 2,063 – (32,683) (12,355) (108,326) (57,374) (20,657) (7,979) (11,361) 27,581 – – 9,481 37,062 79,180 6,785 1,666 (51,711) (4,020) (93,026) (20,972) – – (8,312) (479,626) (248,672) (169,590) – 259,778 130,538 (51,310) (136,308) (20,853) 3,976 (5,012) 180,809 (53,580) 80,436 (37,607) 275,157 80,526 (39,212) (69,072) (18,380) (1,739) (4,182) 185,491 60,285 20,151 (10,323) 57,899 110,280 (8,233) (38,095) (23,037) 7,962 3,576 100,029 9,619 10,532 Cash and cash equivalents at the end of the year $ 26,856 $ 80,436 $ 20,151 See accompanying notes. 12 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T 1996 1995 1994 (In thousands) For each of the three years in the period ended December 31, 1996 Supplemental schedule of noncash investing and financing activities I N V E S T I N G A C T I V I T I E S : Acquisition of real estate facilities in exchange for common and preferred stock, the assumption of mortgage notes payable, the cancellation of mortgage notes receivable and the reduction of investment in real estate entities $ (4,292) $ (87,941) $(42,656) Business combinations (Note 3): Real estate facilities Investment in real estate entities Mortgage notes receivable Other assets Intangible assets Accrued and other liabilities Notes payable Minority interest Reduction of investment in real estate entities in exchange for real estate facilities Acquisition of partnership interests in real estate entities in exchange for common stock Reduction in other assets – deposits on pending real estate acquisitions F I N A N C I N G A C T I V I T I E S : Cancellation of mortgage notes receivable to acquire real estate facilities Assumption of mortgage notes payable upon the acquisition of real estate facilities Accrued and unpaid distributions Issuance of Preferred Stock: Series B Preferred Stock to acquire real estate facilities Mandatory Convertible Preferred Stock, Series CC to acquire interest in consolidated real estate partnerships Mandatory Convertible Participating Preferred Stock to acquire interest in (531,794) 124,696 – (5,849) – 15,399 – 20,139 1,891 – – 700 1,701 – – 58,955 (230,519) (385,222) (6,667) (8,862) (232,726) 17,134 96,728 17,034 – (4,034) – 16,435 60,908 638 – – consolidated real estate partnerships – 28,470 Issuance of Common Stock: In connection with mergers Acquire real estate facilities Acquire partnership interests in real estate entities In connection with conversion of Convertible Preferred Stock Issuance of Class B Common Stock in connection with mergers Conversion of 8.25% Convertible Preferred Stock Conversion of Mandatory Convertible Preferred Stock See accompanying notes. 204,932 – – 29,486 – (1,526) (28,470) 573,756 10,598 4,034 – 73,500 – – (57,415) – – (1,620) – 695 – – – – 4,350 24,441 11,715 – 2,150 – – 37,369 – – – – – – 13 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements D E C E M B E R 31, 19 9 6 1 . D E S C R I P T I O N O F T H E B U S I N E S S Public Storage, Inc. (the “Company”) is a California corporation which was organized in 1980. The Company is a fully integrated, self-administered and self-managed real estate investment trust (“REIT”) that acquires, develops, owns and operates self-storage facilities which offer self-storage spaces for lease, usually on a month-to-month basis, for personal and business use. The Company, to a lesser extent, also owns and operates commercial properties facilities containing commercial and industrial rental space. Prior to November 16, 1995, the Company’s operations were managed, pursuant to contractual arrangements, by Public Storage Advisers, Inc. (the “Adviser”), the Company’s investment advisor, by Public Storage Management, Inc. (“PSMI”), its self-storage facilities property operator and by Public Storage Commercial Properties Group, Inc. (“PSCP”), its business park facility operator. On November 16, 1995, in a series of mergers among PSMI and its affiliates, culminating in the merger of PSMI into the Company (the “PSMI Merger’’), the Company became self-administered and self-managed and acquired substantially all of the United States real estate operations of PSMI (Note 3). The Company invests in real estate facilities primarily through the acquisition of wholly-owned facilities combined with the acquisition of equity interests in real estate entities owning real estate facilities. At December 31, 1996, the Company had direct and indirect equity interests in 1,109 properties located in 38 states, including 1,064 self-storage facilities and 45 commercial properties. All of these facilities are operated by the Company under the “Public Storage” name. 2 . S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S Basis of presentation The consolidated financial statements include the accounts of (i) the Company, (ii) majority-owned subsidiaries involved in the sale of locks and boxes, rental of trucks and portable self-storage, and (iii) twenty-one limited partnerships in which the Company has significant economic interest (generally in excess of 50%) and is able to exercise significant control (the “Consolidated Partnerships”). Collectively, the Company and the Consolidated Partnerships own a total of 756 real estate facilities, consisting of 721 self-storage facilities and 35 commercial properties. The Company also has equity investments in 41 other affiliated limited partnerships and REITs owning in aggregate 353 real estate facilities (343 self-storage facilities and 10 commercial properties) which are managed by the Company. The Company’s ownership interest in such real estate entities is less than 50% of the total equity interest and, accordingly, the Company’s investments in these real estate entities are accounted for using the equity method. Use of estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles 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, the Company is not taxed on that portion of its taxable income which is distributed to its shareholders provided that the Company meets certain tests. The Company believes it has met these tests during 1996, 1995 and 1994; accordingly, no provision for income taxes has been made in the accompanying financial statements. Financial instruments For purposes of financial statement presentation, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The carrying amount of cash and cash equivalents and mortgage notes receivable approximates fair value because, with respect to cash and cash equivalents, maturities are less than three months and with respect to the mortgage notes receivable interest rates approximate market rates for the type of real estate securing such loans. The carrying amount of the Company’s fixed rate long-term debt is estimated using discounted cash flow analyses based on incremental borrowing rates the Company believes it could obtain with similar terms and maturities. 14 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Real estate facilities Real estate facilities are recorded at cost. 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. Allowance for possible losses The Company has no allowance for possible losses relating to any of its real estate investments, long-lived assets and mortgage notes receivable. The need for such an allowance is evaluated by management by means of periodic reviews of its investment portfolio. Intangible assets Intangible assets consist of property management contracts ($165,000,000) and the cost over the fair value of net tangible and identifiable intan- gible assets ($67,726,000) acquired in the PSMI Merger. Intangible assets are amortized straight-line over 25 years. At December 31, 1996 and 1995, intangible assets are net of accumulated amortization of $10,473,000 and $1,164,000, respectively. Included in depreciation and amortization expense is $9,309,000 in 1996 and $1,164,000 in 1995 (for the period from November 16, 1995 through December 31, 1995) related to the amortization of intangible assets. Revenue and expense recognition Property rents are recognized as earned. Equity in earnings of real estate entities are recognized based on the Company’s ownership interest in the earnings of each of the unconsolidated real estate entities. Leasing commissions relating to the business park operations are expensed as incurred. Environmental costs The Company’s policy is to accrue environmental assessments and/or remediation costs when it is probable that such efforts will be required and the related costs can be reasonably estimated. The majority of the Company’s real estate facilities were acquired prior to the time that it was customary to conduct environmental assessments. During 1995, the Company and the Consolidated Partnerships conducted independent environ- mental investigations of their real estate facilities. As a result of these investigations, the Company recorded an amount which, in management’s best estimate and based upon independent analysis, was sufficient to satisfy anticipated costs of known remediation requirements. At December 31, 1995, the Company accrued $2,741,000 for estimated environmental remediation costs. Similar to the Company, real estate entities in which the Company accounts for using the equity method recorded environmental accruals at the end of 1995. The Company’s pro rata share, based on its own- ership interest, totaled $510,000 and is included in “Equity in earnings of real estate entities” in 1995. Although there can be no assurance, the Company is not aware of any environmental contamination of any of its facilities which individually or in the aggregate would be material to the Company’s overall business, financial condition, or results of operations. Net income per common share Net income per common share is computed using the weighted average common shares outstanding (adjusted for stock options). The inclusion of the Class B Common Stock in the determination of earnings per common share has been determined to be anti-dilutive – after giving effect to the pro forma additional income required to satisfy certain contingencies (Note 11) required for the Class B common stock to convert into common stock – and, accordingly, the conversion of the Class B common stock into common stock has not been assumed. The Company’s preferred stocks (Note 11) were determined not to be common stock equivalents. In computing earnings per common share, pre- ferred stock dividends totaling $68,599,000, $31,124,000 and $16,846,000 for the years ended December 31, 1996, 1995 and 1994, respectively, reduced income available to common stockholders. Fully diluted earnings per common share are not presented, as the assumed conversion of the Company’s convertible preferred stock (Note 11) would be anti-dilutive. Stock-based compensation In October 1995, the FASB issued SFAS No. 123 “Accounting for Stock-Based Compensation” (“Statement 123”) which provides companies an alter- native to accounting for stock-based compensation as prescribed under APB Opinion No. 25 (APB 25). Statement 123 encourages, but does not require companies to recognize expense for stock-based awards based on their fair value at date of grant. Statement 123 allows companies to con- tinue to follow existing accounting rules (intrinsic value method under APB 25) provided that pro-forma disclosures are made of what net income and earnings per share would have been had the new fair value method been used. The Company has elected to adopt the disclosure requirements of Statement 123 but will continue to account for stock-based compensation under APB 25. Statement 123’s disclosure requirements are applicable to stock-based awards granted in fiscal years beginning after December 15, 1994. 15 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) Reclassifications Certain reclassifications have been made to the consolidated financial statements for the years ended December 31, 1995 and 1994 in order to conform with the 1996 presentation. 3 . B U S I N E S S C O M B I N A T I O N S Mergers with affiliated REITs During 1996, the Company completed merger transactions with eight affiliated public REITs whereby the Company acquired all the outstanding stock of the REITs which it did not previously own in exchange for cash and common stock of the Company. The aggregate acquisition cost of these mergers is summarized as follows: Entity (In thousands) Public Storage Properties IX, Inc. (“Properties 9”) PS Business Parks, Inc. (“PSBP”) Storage Properties, Inc. (“SPI”) Public Storage Properties X, Inc. (“Properties 10”) Public Storage Properties XII, Inc. (“Properties 12”) Partners Preferred Yield, Inc. (“PPY”), Partners Preferred Yield II, Inc. (“PPY-2”) Partners Preferred Yield III, Inc. (“PPY-3”) Date of merger March 26, 1996 March 26, 1996 June 27, 1996 September 16, 1996 September 16, 1996 December 23, 1996 December 23, 1996 December 23, 1996 Common Stock $ 24,719 5,249 17,148 26,012 33,157 38,076 41,790 18,781 $204,932 Merger consideration Cash $ 9,907 2,719 4,801 14,178 7,436 13,922 13,692 5,787 $72,442 Pre-existing investment Total $12,937 3,337 1,799 9,333 9,472 18,179 18,077 6,327 $79,461 $ 47,563 11,305 23,748 49,523 50,065 70,177 73,559 30,895 $356,835 During 1995, the Company completed merger transactions with two affiliated public REITs whereby the Company acquired all the outstanding stock of the REITs for an aggregate cost of $135,406,000, consisting of the issuance of 6,664,287 shares of the Company’s common stock ($99,972,000) and $35,434,000 in cash. The fair market values of the assets acquired and liabilities assumed were: (i) real estate facilities – $140,775,000, (ii) other assets – $1,440,000, and (iii) accrued and other liabilities – $6,809,000. Affiliated Partnership acquisitions: During 1996, the Company increased its ownership interest in three affiliated limited partnerships. Prior to the acquisitions, the Company accounted for its investment in each of the three partnerships using the equity method. As a result of increasing its ownership interest and control of the part- nerships, the Company began to consolidate the accounts of the partnerships in the Company’s consolidated financial statements. These trans- actions are summarized as follows: Entity (In thousands) PS Institutional Fund (“PSIF”) Diversified Storage Fund (“Diversified”) Diversified Storage Fund II (“Diversified II”) Percentage of Limited Partner Units Purchased 64% 100% 100% Date Purchased March 1996 April 1996 April 1996 Consideration paid to acquired Limited Partnership Units Preferred Stock $ – 39,410 19,545 $58,955 Cash $41,080 – – $41,080 The Company’s Pre-existing investment $27,863 11,565 5,807 $45,235 Total $ 68,943 50,975 25,352 $145,270 During 1995, the Company increased its ownership interest and control of twelve limited partnerships. As a result, commencing in 1995, the Company began to consolidate the accounts of these partnerships for financial statement purposes. The aggregate amount of the interests acquired totaled $48,410,000, consisting of the issuance of $28,470,000 of Mandatory Convertible Participating Preferred Stock and cash of $19,940,000. PSMI merger On November 16, 1995, in a series of mergers among PSMI and its affiliates, culminating in the merger of PSMI into the Company (the ‘’PSMI Merger’’), the Company became self-administered and self-managed and acquired substantially all of the United States real estate operations of PSMI. As a result of the PSMI Merger, the Company’s name was changed from Storage Equities, Inc. to Public Storage, Inc. The aggregate consideration paid by the Company for the net assets acquired in the PSMI Merger (including expenses of $2.0 million) was 16 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T $549,284,000, consisting of 29,449,513 shares of common stock ($473,784,000), 7,000,000 shares of Class B common stock ($73,500,000) (Note 11). The real estate operations acquired in the PSMI Merger included: (1) the ‘’Public Storage’’ name, (2) general and limited partnership interests in 47 limited partnerships owning an aggregate of 286 self-storage facilities, (3) shares of common stock in 16 REITs owning an aggregate of 218 self-storage facilities and 14 business park properties, (4) seven wholly-owned properties, (5) all-inclusive deeds of trust secured by ten self- storage facilities, (6) property management contracts, exclusive of facilities owned by the Company, for 563 self-storage facilities and, through ownership of a 95% economic interest in a subsidiary, 24 business park properties and (7) a 95% economic interest in another subsidiary that currently sells locks and boxes in self-storage facilities operated by the Company. Each of the above mergers with affiliated REIT’s, acquisitions of partnership interests, and merger with PSMI discussed above has been accounted for as a purchase; accordingly, allocations of the total acquisition cost to the net assets acquired were made based on the fair value of such assets and liabilities as of the dates of each respective transaction. The fair market values of the assets acquired and liabilities assumed with respect to the transactions occurring in 1996 and 1995 are summarized as follows: (In thousands) 1996 business combinations: Real estate facilities Other assets Accrued and other liabilities Minority interest 1995 business combinations: Real estate facilities Investments in real estate facilities Mortgage notes receivable Other assets Intangible assets Accrued and other liabilities Notes payable Minority interest REIT mergers Partnership Acquisitions PSMI Merger Total $364,984 5,032 (13,181) – $356,835 $140,775 – – 1,440 – (6,809) – – $135,406 $166,810 817 (2,218) (20,139) $145,270 $ 69,801 (4,464) – 2,851 – (701) (3,387) (15,690) $ 48,410 $ $ – – – – – $ 19,943 389,686 6,667 4,571 232,726 (9.624) (93,341) (1,344) $549,284 $531,794 5,849 (15,399) (20,139) $502,105 $230,519 385,222 6,667 8,862 232,726 (17,134) (96,728) (17,034) $733,100 The historical operating results of the above business combinations prior to each respective acquisition date have not been included in the Company’s historical operating results. Pro forma data (unaudited) for the years ended December 31, 1996, 1995 and 1994 as though (i) business combinations and (ii) the public issuances of common and preferred stock (with the exception of the Series G, Series H, and Series I) during 1996, 1995 and 1994 and the use of the proceeds therefrom had been effective at the beginning of each period as follows: (In thousands except per share data) Revenues Net income Net income per common share For the Year Ended December 31, 1996 $378,718 $163,731 $1.11 1995 $343,135 $129,829 $1.10 1994 $354,936 $139,956 $1.26 The pro forma data does not purport to be indicative either of results of operations that would have occurred had the transactions occurred at the beginning of each period or future results of operations of the Company. Certain pro forma adjustments were made to the combined historical amounts to reflect (i) expected reductions in general and administrative expenses, (ii) estimated increased interest expense from bank borrowings to finance the cash portion of the acquisition cost, (iii) estimated increase in depreciation and amortization expense, and (iv) elimination of advisory fee expense. 4 . R E A L E S T A T E F A C I L I T I E S 17 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) Activity in real estate facilities during 1996, 1995 and 1994 is as follows: (In thousands) Operating Facilities: Beginning balance Property acquisitions: Business combinations (Note 3) Other acquisitions Developed facilities Acquisition of minority interest (Note 9) Capital improvements Property dispositions Ending balance Construction in progress: Beginning balance Current development cost Newly opened development facilities Ending balance Accumulated depreciation: Beginning balance Additions during the year Property dispositions Ending balance 1996 1995 1994 $1,405,155 $ 967,718 $ 764,126 531,794 202,696 18,261 7,226 20,366 – 230,519 191,002 5,265 (223) 11,361 (487) 2,185,498 1,405,155 7,979 46,097 (18,261) 35,815 (241,966) (55,689) – (297,655) – 13,244 (5,265) 7,979 (202,745) (39,376) 155 (241,966) 57,415 135,682 – 4,820 8,312 (2,637) 967,718 – – – – (175,621) (28,099) 975 (202,745) Total real estate facilities $1,923,658 $1,171,168 $ 764,973 During 1996, the Company acquired a total of 154 real estate facilities for an aggregate cost of $531,794,000, in connection with certain busi- ness combinations (Note 3). The Company also acquired an additional 58 real estate facilities from third parties with an aggregate acquisition cost of $202,696,000 consisting of the cancellation of mortgage notes receivable ($700,000), cancellation of pre-existing investments ($1,891,000), assumption of mortgage notes payable ($1,701,000), and cash ($198,404,000). Commencing in 1995, the Company began to construct self-storage facilities. Through December 31, 1996, the Company constructed and opened for operation five facilities, one of which began operations in August 1995 and four in 1996. Included in real estate facilities at December 31, 1996 is approximately $35,815,000 of costs related to the remaining 11 facilities under construction and the 17 additional facilities that the Company has plans to develop. During 1995, the Company acquired a total of 95 real estate facilities for an aggregate cost of $230,519,000 in connection with certain business combinations. During 1995, the Company also acquired an additional 58 real estate facilities for an aggregate cost of $184,861,000 (including the facility developed in 1995), consisting of the cancellation of mortgage notes receivable ($16,435,000), the assumption of mortgage notes payable ($60,908,000) and cash ($107,518,000). A substantial number of the real estate facilities acquired during 1996, 1995 and 1994 were acquired from affiliates with an aggregate acquisi- tion cost of approximately $531,794,000, $300,193,000 and $119,211,000 respectively. At December 31, 1996, the adjusted basis of real estate facilities for Federal income tax purposes was approximately $1,404.0 million, net of accumulated depreciation of $598.3 million. 5 . I N V E S T M E N T S I N R E A L E S T A T E E N T I T I E S During 1996, the Company’s equity in real estate entities decreased principally as a result of business combinations whereby the Company elimi- nated approximately $124.7 million of pre-existing equity in real estate entity investments. Offsetting this decrease were additional investments in numerous other unconsolidated affiliates for $83,893,000 in cash. During 1995, the Company (i) acquired limited and general partnership interest in 47 partnerships and common stock in 16 REITs in connection with the PSMI Merger at an aggregate cost of $389,686,000, (ii) acquired additional interests in some of the same partnerships and REITs for an aggregate cost of $23,953,000, consisting of Common Stock ($4,034,000) and cash ($19,919,000), and (iii) reclassified investments in partnerships which, commencing in 1995, are consolidated with the Company ($4,464,000). Prior to 1995, the Company’s investment in real estate entities generally consisted of limited and general partnership interests in real estate limited partnerships which were accounted for using the cost method. At December 31, 1996, the Company’s investments in these real estate entities consist generally of ownership interests in 41 affiliated partner- 18 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T ships and common stock in eight affiliated REITs. Such interests consist of ownership interests ranging from 15% to 45% and are accounted for using the equity method of accounting. Accordingly, earnings are recognized by the Company based upon the Company’s ownership interest in each of the partnerships and REITs. Provisions of the governing documents of the partnerships and REITs provide for the payment of preferred cash distribu- tions to other investors (until certain specified amounts have been paid) without regard to the pro rata interest of investors in current earnings. Equity in earnings of real estate entities for 1996 and 1995 principally consists of the Company’s pro rata share of earnings for those interests acquired in the PSMI Merger. During 1996 and 1995, the Company recognized earnings from its investments of $22,121,000 and $3,763,000, respectively, and received cash distributions totaling $27,326,000 and $5,580,000, respectively. Included in equity in earnings of real estate enti- ties for 1996 and 1995 is the Company’s share of depreciation expense ($9,556,000 and $926,000, respectively) and environmental costs ($510,000 in 1995, none in 1996) of the real estate entities. In addition, equity in earnings of real estate entities includes amortization totaling $7,894,000 in 1996 and $1,119,000 in 1995 (from date of the PSMI Merger through the end of the year) representing the amortization of the Company’s cost basis over the underlying book value of the Company’s equity interest in each of the entities. At December 31, 1996, the unamortized excess of the Company’s investment over its equity in the underlying net assets of these real estate entities at the date of acquisition was approximately $154.5 million. Summarized combined financial data (based on historical cost) with respect to those real estate entities in which the Company had an owner- ship interest at December 31, 1996 are as follows: (In thousands) Rental income Total revenues Cost of operations Depreciation Net income Total assets, net of accumulated depreciation Total debt Total equity Year ended December 31, 1996 $180,197 182,036 65,417 27,332 75,937 834,695 89,349 710,118 1995 $172,675 175,150 62,542 27,368 69,467 839,775 95,305 708,768 6 . M O R T G A G E N O T E S R E C E I V A B L E F R O M A F F I L I A T E S At December 31, 1996, mortgage notes receivable of $25,016,000 bear interest at stated rates ranging from 7.4% to 14.0% and are secured by 13 self-storage facilities owned by affiliates of the Company. During 1996, the Company acquired a $1,970,000 mortgage note receivable from a third party (secured by a self-storage facility) and provided loans totaling $1,739,000 to affiliated limited partnerships. During 1995, in connection with the PSMI Merger, the Company acquired mortgage notes receivable totaling $6,667,000 which are secured by self-storage facilities owned by affiliated entities. The Company canceled mortgage notes with a net carrying value of $700,000 and $16,435,000 during 1996 and 1995, respectively, as part of the acquisition cost of the underlying real estate facilities securing the mortgage notes (Note 4). 7 . R E V O L V I N G L I N E O F C R E D I T As of December 31, 1996, the Company had no borrowings on its unsecured credit agreement with a group of commercial banks. On February 25, 1997, the credit agreement was amended (the “Credit Facility”) to increase the available borrowings to $150.0 million and extend the expiration date to July 31, 2001. The expiration date may be extended by one year on each anniversary of the credit agreement. Interest on outstanding borrowings is payable monthly. At the option of the Company, the rate of interest charged is equal to (i) the prime rate or (ii) a rate ranging from the London Interbank Offered Rate (“LIBOR”) plus 0.40% to LIBOR plus 1.10% depending on the Company’s credit ratings and coverage ratios, as defined. In addition, the Company is required to pay a quarterly commitment fee of 0.250% (per annum) of the unused portion of the Credit Facility. The Credit Facility allows the Company, at its option, to request the group of banks to propose the interest rate they would charge on specific bor- rowings not to exceed $50 million. However, in no case may the interest rate proposal be greater than the amount provided by the Credit Facility. Under covenants of the Credit Facility, the Company is required to (i) maintain a balance sheet leverage ratio of less than 0.40 to 1.00, (ii) main- tain net income of not less than $1.00 for each fiscal quarter, (iii) maintain certain cash flow and interest coverage ratios (as defined) of not less than 1.0 to 1.0 and 5.0 to 1.0, respectively and (iv) maintain a minimum total shareholders’ equity (as defined). In addition, the Company is limited in its ability to incur additional borrowings (the Company is required to maintain unencumbered assets with an aggregate book value equal to or greater than three times the Company’s unsecured recourse debt) or sell assets. The Company was in compliance with the covenants of the Credit Facility at December 31, 1996. 19 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) 8 . N O T E S P A Y A B L E Notes payable at December 31, 1996 and 1995 consist of the following: (In thousands) 7.08% unsecured senior notes, due November 2003 Mortgage notes payable: 10.55% mortgage notes secured by real estate facilities, principal and interest payable monthly, due August 2004 7.07% to 11.10% mortgage notes secured by real estate facilities, principal and interest payable monthly, due at varying dates between December 1997 and September 2028 Variable rate mortgage notes secured by real estate facilities 1996 1995 Carrying amount $ 59,750 Fair value $ 59,750 Carrying amount $ 65,500 Fair value $ 65,500 32,115 34,964 33,699 36,959 16,578 – $108,443 16,578 – 22,875 35,978 22,875 35,978 $111,292 $158,052 $161,312 During 1995, in connection with the PSMI Merger, the Company assumed the 7.08% unsecured senior notes payable. The senior notes require interest and principal payments to be paid semi-annually and have various restrictive covenants, all of which have been met at December 31, 1996. The 10.55% mortgage notes consist of five notes which are cross-collateralized by 19 properties and are due to a life insurance company. Although there is a negative spread between the carrying value and the estimated fair value of the notes, the notes provide for the prepayment of principal subject to the payment of penalties which exceed this negative spread. Accordingly, prepayment of the notes at this time would not be economically practicable. Mortgage notes payable are secured by 30 of the Company’s real estate facilities having an aggregate net book value of $68.1 million at December 31, 1996. At December 31, 1996, approximate principal maturities of notes payable are as follows: (in thousands) 1997 1998 1999 2000 2001 Thereafter 7.08% Unsecured Senior Notes Fixed Rate Mortgage Debt (weighted average rate of 10.28%) $ 6,500 7,250 8,000 8,750 9,500 19,750 $59,750 $ 4,744 7,908 6,484 2,721 2,238 24,598 $48,693 Total $ 11,244 15,158 14,484 11,471 11,738 44,348 $108,443 Interest paid (including interest related to the borrowings on the Credit Facility) during 1996, 1995 and 1994 was $10,312,000, $8,595,000 and $5,940,000, respectively. In addition, in 1996 and 1995, the Company capitalized interest totaling $1,861,000 and $307,000, respectively, related to construction of real estate facilities. 9 . M I N O R I T Y I N T E R E S T In consolidation, the Company classifies ownership interests other than its own in the net assets of each of the Consolidated Partnerships as minority interest on the consolidated financial statements. Minority interest in income consists of the minority interests’ share of the operating results of the Company relating to the consolidated operations of the Consolidated Partnerships. During 1996, the Company acquired limited partnership interests in the Consolidated Partnerships in several transactions for an aggregate cost of $15,419,000. These transactions had the effect of reducing minority interest by approximately $8,193,000 (the historical book value of such interests in the underlying net assets of the partnerships). The excess of the underlying book value over cost ($7,226,000) has been allocated to real estate facilities in consolidation. In 1995 and 1994, the Company acquired interests in the Consolidated Partnerships at an aggregate cost of $32,683,000 and $51,711,000, respectively, reducing minority interest by approximately $32,906,000 and $46,891,000, respectively. The excess of cost over underlying book values was allocated to real estate facilities in consolidation. During 1996 and 1995, in connection with certain business combinations (Note 3) minority interest was increased by $20,139,000 and $17,034,000, respectively, representing the remaining partners’ equity interests in the aggregate net assets of the consolidated partnerships. 20 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T 10 . P R O P E R T Y M A N A G E M E N T A N D A D V I S O R Y C O N T R A C T S Pursuant to the PSMI Merger, the Company became self-advised and self-managed; accordingly, effective November 16, 1995, the Company no longer incurs either advisory fees or property management fees. Prior to the PSMI Merger, PSMI provided property operation services for a fee to the Company under a management agreement and an affiliate of PSMI administered the day-to-day investment operations for a fee pursuant to an advisory contract. Pursuant to the management agreement, PSMI or an affiliate of PSMI operated all of the properties in which the Company invested in for a fee which is equal to 6% of the gross revenues of the self-storage facilities spaces managed and 5% of the gross revenues of the business park facilities operated. Management fees relating to the Company’s real estate facilities, which are included in cost of operations, amounted to $10,232,000 and $8,355,000 in 1995 and 1994, respectively. During 1994 and 1995 (from January 1, 1995 through November 16, 1995), the Company paid advisory fees equal to $4,983,000 and $6,437,000 pursuant to the advisory contract. In connection with the PSMI Merger, the Company acquired property management contracts for (i) self-storage facilities owned by affiliated entities and, to a lesser extent, third parties and (ii) through ownership of a 95% economic interest in a subsidiary, commercial properties. These facilities constitute all of the United States self-storage facilities and commercial properties doing business under the “Public Storage” name and, with the exception of third party properties, all those in which the Company had an interest. At December 31, 1996, the Company managed 1,101 self-storage facilities (721 owned by consolidated facilities, 343 owned by unconsolidated affiliates and 37 owned by third parties) and 45 com- mercial properties (35 owned by consolidated facilities and 10 owned by unconsolidated affiliates). The property management contracts generally provide for compensation equal to 6%, in the case of the self-storage facilities, and 5%, in the case of the commercial properties of gross revenues of the facilities managed. Under the supervision of the property owners, the Company coordinates rental policies, rent collections, marketing activities, the purchase of equipment and supplies, maintenance activity, and the selection and engage- ment of vendors, suppliers and independent contractors. In addition, the Company assists and advises the property owners in establishing policies for the hire, discharge and supervision of employees for the operation of these facilities, including resident managers, assistant managers, relief managers and billing and maintenance personnel. 11 . S H A R E H O L D E R S ’ E Q U I T Y Preferred Stock At December 31, 1996 and 1995, the Company had the following series of Preferred Stock outstanding: Series Series A Series B Series C Series D Series E Series F Series G Series H Series I Total Senior Preferred Stock Convertible Mandatory Convertible – Series CC Mandatory Convertible Participating Total Convertible Preferred Stock Dividend Rate 10.000% 9.200% Adjustable 9.500% 10.000% 9.750% 8.875% 8.45% 8.625% 8.25% 13.00% Variable At December 31, 1996 At December 31, 1995 Shares Outstanding 1,825,000 2,386,000 1,200,000 1,200,000 2,195,000 2,300,000 6,900 6,750 4,000 Carrying Amount $ 45,625,000 59,650,000 30,000,000 30,000,000 54,875,000 57,500,000 172,500,000 168,750,000 100,000,000 Shares Outstanding 1,825,000 2,386,000 1,200,000 1,200,000 2,195,000 2,300,000 6,900 – – Carrying Amount $ 45,625,000 59,650,000 30,000,000 30,000,000 54,875,000 57,500,000 172,500,000 – – 11,123,650 718,900,000 11,112,900 450,150,000 2,238,975 58,955 – 55,974,000 58,955,000 – 2,297,930 114,929,000 2,300,000 – 31,200 2,331,200 57,500,000 – 28,470,000 85,970,000 13,421,580 $833,829,000 13,444,100 $536,120,000 During 1996, the Company issued 6,750,000 depositary shares (depositary shares, each representing 1/1,000 of a share) of its 8.45% Series H Preferred Stock (January 25, 1996) raising net proceeds of approximately $163.1 million and 4,000,000 depositary shares (depositary shares, each representing 1/1,000 of a share) of its 85⁄8% Series I Preferred Stock (November 1, 1996) raising net proceeds of approximately $96.7 million. In April 1996, in connection with the acquisition of limited partnership interests (Note 3), the Company issued $58,955,000 (58,955 shares) of its Mandatory Convertible Preferred Stock, Series CC (the “Series CC Preferred Stock”). The Series CC Preferred Stock ranks junior to the Company’s Cumulative Senior Preferred Stock with respect to general preference rights and has a liquidation value of $1,000 per share. Other significant 21 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) terms of the Series CC Preferred Stock include: (i) quarterly distributions equal to $32.50 per share, (ii) conversion, at anytime at the option of the holder, into common stock of the Company at a conversion price of $28.56 or 35.014 shares of common stock for each share of Series CC Preferred Stock, and (iii) automatic conversion into common stock of the Company on March 31, 2000 at the conversion price described above. During the second quarter of 1996, the Mandatory Convertible Participating Preferred Stock was exchanged into 1,611,265 shares of common stock. Costs incurred in connection with the exchange have been charged to Paid in Capital. The Series A through Series I (collectively the “Cumulative Senior Preferred Stock”) have general preference rights with respect to liquidation and quarterly distributions. With respect to the payment of dividends and amounts upon liquidation, all of the Company’s Convertible Preferred Stock ranks junior to the Cumulative Senior Preferred Stock and any other shares of preferred stock of the Company ranking on a parity with or senior to the Cumulative Senior Preferred Stock. The Convertible Preferred Stock ranks senior to the common stock, any additional class of common stock and any series of preferred stock expressly made junior to the Convertible Preferred Stock. Holders of the Company’s preferred stock, except under certain conditions and as noted above, will not be entitled to vote on most matters. In the event of a cumulative arrearage equal to six quarterly dividends or failure to maintain a Debt Ratio (as defined) of 50% or less, holders of all outstanding series of preferred stock (voting as a single class without regard to series) will have the right to elect two additional members to serve on the Company’s Board of Directors until events of default have been cured. At December 31, 1996, there were no dividends in arrears and the Debt Ratio was 4.2%. Except under certain conditions relating to the Company’s qualification as a REIT, the Senior Preferred Stock are not redeemable prior to the following dates: Series A – September 30, 2002, Series B – March 31, 2003, Series C – June 30, 1999, Series D – September 30, 2004, Series E – January 31, 2005, Series F – April 30, 2005, Series G – December 31, 2000, Series H – January 31, 2001, Series I – October 31, 2001. On or after the respective dates, each of the series of Senior Preferred Stock will be redeemable at the option of the Company, in whole or in part, at $25 per share (or depositary share in the case of the Series H and Series I), plus accrued and unpaid dividends. The Convertible Preferred Stock is convertible at any time at the option of the holders of such stock into shares of the Company’s common stock at a conversion rate of 1.6835 shares of common stock for each share of Convertible Preferred Stock, subject to adjustment in certain circum- stances. On, or after July 1, 1998, the Convertible Stock will be redeemable for shares of the Company’s common stock at the option of the Company, in whole or in part, at a redemption price of 1.6835 shares of common stock for each share of Convertible Stock (subject to adjustment in certain circumstances), if for 20 trading days within any period of 30 consecutive trading days (including the last trading day of such period), the closing price of the common stock on its principal trading market exceeds $14.85 per share (subject to adjustment in certain circumstances). The Convertible Preferred Stock is not redeemable for cash. Common stock During 1996, 1995 and 1994, the Company issued shares of its common stock as follows: (Dollar amounts in thousands) Shares Amount Shares Amount Shares Amount 1996 1995 1994 Public offerings In connection with mergers (Note 3) Issuance costs of mergers Exercise of stock options Issuance to affiliates Conversion of Mandatory Convertible Preferred Stock Acquisition of interests in real estate entities Acquisition of real estate facilities (Note 4) Conversion of 8.25% Convertible Preferred Stock 6,151,200 8,839,181 – 100,663 43,197 1,611,265 – – 102,721 $127,501 204,932 – 2,037 1,000 27,960 – – 1,526 5,482,200 36,113,800 – 46,670 40,000 – 257,067 747,355 – $ 82,068 573,756 (2,527) 403 582 – 4,034 10,598 – 7,984,000 2,593,914 – 82,666 109,857 – – – – $108,083 38,498 (1,124) 689 1,701 – – – – 16,848,227 $364,956 42,687,092 $668,914 10,770,437 $147,847 Shares of common stock issued to affiliates in 1996, 1995 and 1994 were issued for cash. All the shares of common stock, with the exception of the shares issued in connection with the exercise of stock options, were issued at the prevailing market price at the time of issuance. At December 31, 1996, the Company had 5,250,004 shares of common stock reserved in connection with the Company’s stock option plans (Note 12) and 12,834,000 shares of common stock reserved for the conversion of the Convertible Preferred Stock, Class B Common Stock and Series CC convertible preferred stock. On March 18, 1997, the Company publicly issued 4,600,000 shares of common stock, raising net proceeds of approximately $126.5 million. The Company intends to use the net proceeds from this offering to make investments in real estate and fund the activities of its portable self-storage operations. 22 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Class B Common Stock The Class B Common Stock was issued in connection with the PSMI Merger. Under the terms of the merger agreement, the issuance of the Class B Common Stock was subject to certain conditions which were satisfied in December 1995 and the Class B Common Stock was issued on January 2, 1996. The Company has reflected the Class B Common Stock as outstanding as of December 31, 1995. The Class B Common Stock will (i) not participate in distributions until the later to occur of funds from operations (“FFO”) per Common Share as defined below, aggregating $1.80 during any period of four consecutive calendar quarters, or January 1, 2000; thereafter, the Class B Common Stock will participate in distributions (other than liquidating distributions), at the rate of 97% of the per share distributions on the Common Stock, provided that cumulative distributions of at least $0.22 per quarter per share have been paid on the Common Stock, (ii) not participate in liquidat- ing distributions, (iii) not be entitled to vote (except as expressly required by California law) and (iv) automatically convert into Common Stock, on a share for share basis, upon the later to occur of FFO per Common Share aggregating $3.00 during any period of four consecutive calendar quarters or January 1, 2003. For these purposes FFO means net income (loss) (computed in accordance with generally accepted accounting principles) before (i) gain (loss) on early extinguishment of debt, (ii) minority interest in income and (iii) gain (loss) on disposition of real estate, adjusted as follows: (i) plus depre- ciation and amortization (including the Company’s pro-rata share of depreciation and amortization of unconsolidated equity interests and amorti- zation of assets acquired in the Merger, including property management agreements and goodwill), and (ii) less FFO attributable to minority interest. For these purposes, FFO per Common Share means FFO less preferred stock dividends (other than dividends on convertible preferred stock) divided by the outstanding weighted average shares of Common Stock assuming conversion of all outstanding convertible securities and the Class B Common Stock. For these purposes, FFO per share of Common Stock (as defined) was $1.86 for the year ended December 31, 1996. Equity Stock The Company is authorized to issue 200,000,000 shares of Equity Stock. The Articles of Incorporation provide that the Equity Stock may be issued from time to time in one or more series and gives the Board of Directors broad authority to fix the dividend and distribution rights, conversion and voting rights, redemption provisions and liquidation rights of each series of Equity Stock. At December 31, 1996, the Company had no outstanding shares of Equity Stock. Dividends The characterization of dividends for Federal income tax purposes is made based upon earnings and profits of the Company, as defined by the Internal Revenue Code. Distributions declared by the Board of Directors (including distributions to the holders of preferred stock) in 1996, 1995 and 1994 were characterized as ordinary income. The following summarizes dividends paid during 1996, 1995 and 1994 (with the exception of the Series G Preferred Stock distributions which were accrued and unpaid at December 31, 1995): (In thousands, except per share data) Series A Series B Series C Series D Series E Series F Series G Series H Series I Convertible Series CC Mandatory Convertible Participating Common 1996 1995 1994 Per share Total $ 2.500 2.300 1.840 2.375 2.500 2.437 2.219 1.978 .359 2.063 97.500 $54.487 $ 0.880 $ 4,563 5,488 2,212 2,850 5,488 5,606 15,479 13,348 1,438 4,679 5,748 1,700 68,599 67,709 $136,308 Per share $ 2.500 2.300 1.970 2.375 2.292 1.618 0.092 – – 2.063 – $55.322 $ 0.880 Total $ 4,563 5,488 2,364 2,850 5,030 3,721 638 – – 4,744 – 1,726 31,124 38,586 $69,710 Per share $ 2.500 2.300 1.042 0.792 – – – – – 2.063 – – $ 0.850 Total $ 4,563 5,340 1,250 950 – – – – – 4,743 – – 16,846 21,249 $38,095 The dividend rate on the Series C Preferred Stock is adjusted quarterly and is equal to the highest of one of three U.S. Treasury indices (Treasury Bill Rate, Ten-Year Constant Maturity Rate, and Thirty-Year Constant Maturity Rate) multiplied by 110%. However, the dividend rate for any 23 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) dividend period will not be less than 6.75% per annum nor greater than 10.75% per annum. The dividend rate with respect to the first quarter of 1997 will be equal to 7.26% per annum. The Mandatory Convertible Participating Preferred Stock was issued in connection with the acquisition of all of the limited partnership interests in a real estate limited partnership in 1995. Dividends with respect to the Mandatory Convertible Participating Preferred Stock varied depending on operating results of the underlying real estate facilities of the partnership. During June 1996, the Mandatory Convertible Participating Preferred Stock was exchanged for common stock of the Company. 12 . S T O C K O P T I O N S The Company has a 1990 Stock Option Plan (which was adopted by the Board of Directors in 1990 and approved by the shareholders in 1991) (the “1990 Plan”) which provides for the grant of non-qualified stock options. The Company has a 1994 Stock Option Plan (which was adopted by the Board of Directors and approved by the shareholders in 1994) (the “1994 Plan”) and a 1996 Stock Option and Incentive Plan (which was adopted by the Board of Directors and approved by the shareholders in 1996 (the “1996 Plan”), each of which provides for the grant of non-qualified options and incentive stock options. (The 1990 Plan, the 1994 Plan and the 1996 Plan are collectively referred to as the “Plans”). Under the Plans, the Company has granted non-qualified options to certain directors, officers and key employees and service providers 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 Plans vest over a three-year period from the date of grant at the rate of one-third per year and expire (i) under the 1990 Plan, five years after the date they became exercisable and (ii) under the 1994 Plan and 1996 Plan, ten years after the date of grant. The 1996 Plan also provides for the grant of restricted stock to officers, key employees and service providers on terms determined by the Audit Committee of the Board of Directors. No shares of restricted stock have been granted. Information with respect to the Plans during 1996 and 1995 is as follows: Options outstanding January 1 Granted Exercised Canceled Options outstanding December 31 Option price range at December 31 Options exercisable at December 31 Options available for grant at December 31 1996 1995 Number of Options 693,667 1,183,000 (100,663) (23,835) 1,752,169 $8.125 to 25.875 367,947 3,497,835 Average Price per Share $13.61 21.39 10.29 16.02 $19.02 $13.05 Number of Options 512,834 227,500 (46,667) – 693,667 $8.125 to $18.00 302,485 807,000 Average Price per Share $11.88 16.48 8.63 – $13.61 $10.89 In 1996, the Company adopted the disclosure requirement provision of SFAS 123 in accounting for stock-based compensation issued to employees. As of December 31, 1996 and 1995, there were 1,391,500 and 208,500 options outstanding, respectively, that were subject to SFAS 123 disclosure requirements. The fair value of these options was estimated utilizing prescribed valuation models and assumptions as of each respective grant date. Based on the results of such estimates, management determined that there was no material effect on net income or earnings per share for the years ended December 31, 1996 and 1995. The remaining contractual lives were 8.6 and 7.2 years, respectively, at December 31, 1996 and 1995. 13 . P R O P O S E D M E R G E R S In December 1996, Public Storage Properties XIV, Inc. (“Properties 14”) and Public Storage Properties XV, Inc. (“Properties 15”) each agreed, sub- ject to certain conditions, to merge with and into the Company. Properties 14 and Properties 15 are affiliated publicly traded equity REITs. Each of the mergers is conditioned on approval by the respective shareholders of Properties 14 and Properties 15. However, the mergers are not conditioned on approval of each other. The Company expects that if approved by the shareholders the mergers would be completed in April 1997. The estimated value of the Properties 14 and Properties 15 merger is approximately $63.8 million and $58.5 million, respectively. Properties 14 and Properties 15 own 14 properties (912,000 square feet) and 19 properties (1,087,000 square feet), respectively. The Company currently owns approximately 33% and 35% of the economic interest in Properties 14 and Properties 15, respectively. 24 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T 14 . R E S T R U C T U R I N G O F C O M M E R C I A L P R O P E R T I E S O P E R A T I O N S Effective January 2, 1997, the Company restructured its commercial property operations by forming a new private REIT that will concentrate its investing efforts in real estate facilities containing commercial and industrial rental space. The Company’s majority-owned subsidiary, Public Storage Commercial Properties Group, Inc. (which subsequently changed its name to American Office Park Properties, Inc.), its commercial property manager, contributed all its property management contracts to a newly created operating partnership in exchange for the general partnership inter- est. The Company and the Consolidated Partnerships contributed substantially all of their commercial properties to the operating partnership in exchange for limited partnership interests. The limited partnership interests, pursuant to the terms and conditions of the governing documents, are convertible into shares of common stock of American Office Park Properties, Inc. American Office Park Properties, Inc. intends to elect to operate as a REIT as defined in Section 856 of the Internal Revenue Code effective January 1, 1997. The restructuring will not immediately impact total assets, shareholders’ equity, or the operations of the company. The Company believes that the concentration of all the business park facilities and the property manager into one entity will create a vehicle which should facilitate future growth in this segment of the real estate industry. The Company and the affiliates exchanging real estate assets to the new REIT will participate in the growth through its ownership interest in the new REIT. 15 . S U P P L E M E N T A R Y Q U A R T E R L Y F I N A N C I A L D A T A ( U N A U D I T E D ) (In thousands, except per share data) Revenues Net income Per Common Share (Note 2): Net income (In thousands, except per share data) Revenues Net income Per Common Share (Note 2): Net income Three months ended March 31, 1996 $74,967 $32,341 June 30, 1996 $83,133 $37,739 September 30, 1996 December 31, 1996 $88,103 $40,366 $94,919 $43,103 $0.24 $0.27 $0.30 $0.29 Three months ended March 31, 1996 $43,198 $13,200 June 30, 1996 $47,912 $16,551 September 30, 1996 December 31, 1996 $56,938 $19,470 $64,602 $21,165 $0.24 $0.26 $0.26 $0.20 Revenues for each of the three month periods in 1996 and 1995 reflect reclassification to conform with the fiscal 1996 presentation. The three months ended December 31, 1995 reflects the effects of the PSMI Merger. 25 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Report of Independent Auditors The Board of Directors and Shareholders Public Storage, Inc. We have audited the accompanying consolidated balance sheets of Public Storage, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Public Storage, Inc. at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Los Angeles, California February 25, 1997 26 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto. O V E R V I E W : Over the past three years, the Company has effected several business initiatives which have had, and should continue to have, significant effects on the Company’s results of operations and financial condition. The Company’s asset base has expanded rapidly through the acquisition of additional real estate investments which have principally been financed through the issuance of permanent capital in the form of common and preferred stock and the retention of operating cash flow. Since 1993, the Company’s total assets and shareholders’ equity have increased significantly as total assets increased from $666.1 million at December 31, 1993 to $2.6 billion at December 31, 1996, and shareholders’ equity increased from $376.1 million at December 31, 1993 to $2.3 billion at December 31, 1996. Among the more significant transactions that the Company completed during 1994, 1995 and 1996 are summarized as follows: • Increased interests in real estate facilities: Through the acquisition of wholly-owned facilities and the acquisition of interests in real estate entities, the Company’s ownership interest in real estate facilities has increased from 331 facilities at the end of 1993 to 1,109 facilities at the end of 1996. • Mergers with affiliated REITs: Since 1993, the Company has completed eleven mergers with affiliated REITs: one in 1994 with an aggregate cost of $55.8 million, two in 1995 with an aggregate cost of $135.4 million, and eight in 1996 with an aggregate cost of $356.8 million. • Became self-advised and self-managed: On November 16, 1995, the Company became self-advised and self-managed in connection with the merger with Public Storage Management, Inc. (“PSMI”) with an aggregate cost of $549.3 million. In the merger with PSMI (the “PSMI Merger”), the Company acquired all the real estate operations of PSMI, including (i) general and limited partnership interests in 47 limited partnerships owning an aggregate of 286 self-storage facilities, (ii) shares of common stock in 16 REITs owning an aggregate of 218 self-storage facilities and 14 commercial properties, (iii) seven wholly-owned properties, (iv) all-inclusive deeds of trust secured by 10 self-storage facilities, (v) property management contracts, exclusive of facilities owned by the Company, for 563 self-storage facilities and through ownership of a 95% economic interest in a subsidiary, 24 commercial properties and (vi) a 95% economic interest in another subsidiary that currently sells locks and boxes in self-storage facilities operated by the Company. • Issuance of capital stock: To fund the Company’s acquisition activities over the past three years the Company has issued approximately $592.8 million of preferred stock and $321.3 million of common stock in public offerings, and approximately $87.4 million of preferred stock and $830.7 million of common stock in connection with mergers and real estate acquisitions. • Development activities: In 1995, the Company commenced development of self-storage facilities, opening one in 1995 and four in 1996, with eleven under construction at December 31, 1996. • Portable self-storage business: In August 1996, the Company commenced operations in the portable self-storage business facilitated by the acquisition of an existing operator. As of December 31, 1996, the Company opened three new facilities. From December 31, 1996 through March 15, 1997 the Company opened an additional eight facilities. The significant increases in both the Company’s asset and capital base have translated into significant growth in the Company’s overall operat- ing results. The comparative growth in operating results between 1996 and 1995 is principally due to the impact of the PSMI Merger combined with mergers with affiliated REITs. The comparative growth in operating results between 1995 and 1994 is principally due to mergers with affiliated REITs combined with acquisitions of additional real estate facilities and investments in real estate entities. R E S U L T S O F O P E R A T I O N S Net income and earnings per common share: Net income for 1996, 1995 and 1994 was $153,549,000, $70,386,000 and $42,118,000, respec- tively, representing increases over the prior year of 118.2% for 1996 and 67.1% for 1995. Net income allocable to common shareholders (net income less preferred stock dividends) for 1996, 1995 and 1994 was $84,950,000, $39,262,000 and $25,272,000, respectively, representing increases over the prior year of 116.4% for 1996 and 55.4% for 1995. On a per share basis, net income was $1.10 per share (based on weighted average shares outstanding of 77,358,000) for 1996, $0.95 per share (based on weighted average shares outstanding of 41,171,000) for 1995 and $1.05 per share (based on weighted average shares outstanding of 24,077,000) for 1994. The increase in net income per share for 1996 compared to 1995 was the result of improved real estate operations. The 1996 per share amount also reflects earnings dilution caused by (i) development activities ($0.02 per share), (ii) portable self storage operations ($0.01 per share) and (iii) the temporary uninvested net offering proceeds ($0.02 per share) from the issuance of the Series H and Series I preferred stock. The decrease in net income per share for 1995 compared to 1994 was principally due to increasing depreciation expense combined with the accrual of estimated environmental remediation costs at the end of 1995 and a greater number of shares outstanding in 1995. Net income includes depreciation and amortization expense (including depreciation included in equity in earnings of real estate entities) of approximately $70,835,000 ($0.92 per common share) for 1996, $31,449,000 ($0.76 per common share) for 1995, and $14,025,000 ($0.58 per 27 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) common share) for 1994. The fiscal 1995 earnings per common share also includes a reduction of approximately $0.08 per common share relating to the accrual of estimated environmental remediation costs (discussed below). The Company’s business operations consist of its (i) self-storage properties, (ii) commercial properties, (iii) property management activities and (iv) ancillary operations, including the Company’s portable self-storage operations. The Company’s real estate operations account for substantially all of the Company operating activities. During 1996, approximately 94% of the Company’s sources of operating income (income prior to deductions for depreciation, general and administrative expenses, advisory fees and interest expense) was generated from property operations. R E A L E S T A T E O P E R A T I O N S At December 31, 1996, the Company’s investment portfolio consisted of (i) its wholly-owned properties, (ii) properties owned by real estate part- nerships consolidated with the Company (the “Consolidated Partnerships”) and (iii) properties owned by real estate entities (partnerships and REITs) in which the Company’s ownership interest and control are not sufficient to warrant the consolidation of such entities (the “Unconsolidated Entities”). The following table summarizes the Company’s investment in real estate facilities as of December 31, 1996: Number of Facilities in which the Company has an ownership interest Net Rentable Square Footage (In thousands) Self-storage facilities Commercial properties Wholly-owned facilities Facilities owned by Consolidated Partnerships Total consolidated facilities Facilities owned by Unconsolidated Entities 429 292 721 343 Total facilities in which the Company has an ownership interest 1,064 21 14 35 10 45 Total 450 306 756 353 1,109 Self-storage facilities Commercial properties 26,355 17,062 43,417 20,600 64,017 1,503 1,542 3,045 673 3,718 Total 27,858 18,604 43,462 21,273 64,735 The facilities in which the Company has an ownership interest are located in or near major metropolitan markets in 38 states. The Company believes that geographic diversity reduces the impact from regional economic downturns and provides a greater degree of stability to revenues. Self-storage operations: Self-storage rental income and cost of operations presented on the consolidated statements of income reflect the opera- tions of the 721 self-storage facilities owned by the Company and the Consolidated Partnerships. The following table summarizes the operating results (before depreciation) of these facilities for each of the past three years: SELF-STORAGE OPERATIONS: Year Ended December 31, Year Ended December 31, (Dollar amounts in thousands, except rents per square foot) 1996 1995 Rental income: Consistent group Post-1993 acquisitions Cost of operations: Consistent group Post-1993 acquisitions Net operating income: Consistent group Post-1993 acquisitions Consistent group data: Gross margin Weighted average occupancy Average realized annual rent per square foot Average scheduled annual rent per square foot Number of facilities (at the end of the period): Consistent group Cumulative post-1993 acquisitions Net rentable square feet (at the end of the period): Consistent group Cumulative post-1993 acquisitions $121,481 148,948 270,429 $116,587 67,513 184,100 37,438 45,056 82,494 84,043 103,892 40,319 23,077 63,396 76,268 44,436 $187,935 $128,704 69.2% 90.7% $7.68 $7.80 298 423 17,641 25,776 65.4% 89.8% $7.44 $7.20 298 222 17,641 13,137 28 Percentage Change 4.2% 120.6% 46.9% (7.2)% 95.2% 30.1% 10.2% 133.8% 55.7% 5.8% 1.0% 3.2% 8.3% – 90.5% – 96.2% 1995 1994 Percentage Change $116,587 67,513 184,100 $112,763 14,234 126,997 40,319 23,077 63,396 76,268 44,436 40,246 5,020 45,266 72,517 9,214 $120,704 $ 81,731 65.4% 89.8% $7.44 $7.20 298 222 17,641 13,137 64.3% 90.0% $7.08 $6.84 298 67 17,641 4,166 3.4% 374.3% 45.0% 0.2% 359.7% 40.1% 5.2% 382.3% 47.7% 1.7% (0.2)% 5.1% 5.3% – 231.3% – 215.3% P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T The comparative increases in the Company’s self-storage operations from 1994 through 1996 are principally due to the acquisition of additional facilities as indicated in the above table. For the consistent group of facilities owned throughout each of the three fiscal years, year-over-year improvements in rental income of 4.2% in 1996 and 3.4% in 1995 are principally the result of increased realized rent per square foot and, with respect to fiscal 1996, increased weighted average occupancy levels. Commencing in early 1996, the Company began to experiment with a national telephone reservation system designed to provide added customer service. Customers calling either the Company’s toll-free telephone referral system, (800) 44-STORE, or a local Public Storage facility, are directed to the national reservation system where a trained representative discusses with the customer space requirements, price and location preferences and also informs the customer of other products and services provided by the Company. The national telephone reservation system, which is no longer experimental, was not fully operational for most of the Company’s facilities until the fourth quarter of 1996 and is currently handling in excess of 100,000 calls per month. As of December 31, 1996, the national telephone reservation system was supporting rental activity at all of the Company’s properties, with the exception of one major market, which was included in March 1997. In connection with the national telephone reservation system, the Company experimented with pricing and promotional discounts designed to increase rental activity. As a result, promotional discounts increased significantly. Rental income for the Company’s self-storage facilities is net of promotional discounts totaling $4,031,000 and $303,000 for the years ended December 31, 1996 and 1995, respectively. The Company believes that the use of the national telephone reservation system combined with rental discounts has resulted in increased weighted average occupancies. In the second half of 1996, the Company began to increase its scheduled rents charged to new customers (prior to promotional discounts) and to existing tenants where warranted. As a result, for fiscal 1996, both realized and scheduled rents per square foot increased compared to 1995. This trend was also applicable throughout the portfolio of self-storage facilities in which the Company has an ownership interest and manages (see “Supplemental Property Data” below). With the exception of property management fees, most of the self-storage operating costs (i.e. payroll, property taxes, repairs and maintenance, etc.) are generally fixed. As a result of becoming self-managed in connection with the PSMI Merger, the Company no longer incurs property man- agement fees. Cost of operations for 1996 decreased compared to 1995 principally as a result of the elimination of property management fees for 1996. Included in cost of operation for 1995 and 1994 were management fees totaling $9,421,000 and $7,587,000, respectively ($5,966,000 in 1995 and $6,737,000 in 1994 with respect to the consistent group of facilities). However, offsetting the decrease in property management fees in 1996 are expenses with respect to the national telephone reservation system totaling $1,257,000. Development of self-storage facilities: Commencing in 1995, the Company began to construct self-storage facilities. Through December 31, 1996, the Company constructed and opened for operation five facilities, one of which began operations in August 1995 and four in 1996. At December 31, 1996, the Company had eleven self-storage facilities (approximately 707,000 square feet) under construction with an aggregate cost incurred to date of approximately $33.5 million and total additional estimated cost to complete of $22.5 million. Generally the construction period takes 9 to 12 months followed by an 18- to 24-month fill-up process until the newly constructed facility reaches a stabilized occupancy level of approximately 90%. Due to the timing of the employment of the capital to construct the facilities and the relatively long “fill-up” period until the facilities reach a stabilized occupancy level, the Company believes that its development plans may create earnings dilution in the short-term. However, the Company has reached an agreement in principle to develop approximately $220 million of self-storage facilities with a joint venture partner (see “Liquidity and Capital Resources – Development activities”) and expects that the joint development of self-storage facilities will mitigate this earnings dilution to the extent of the joint venturer’s interest. 29 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) Commercial property operations: Commercial property rental income and cost of operations presented on the consolidated statements of income reflect the operations of the 35 facilities owned by the Company and the Consolidated Partnerships. The following table summarizes the operating results (before depreciation) of these facilities for each of the past three years: COMMERCIAL PROPERTY OPERATIONS: Year Ended December 31, Year Ended December 31, (Dollar amounts in thousands, except rents per square foot) 1996 1995 Percentage Change 1995 1994 Percentage Change Rental income: Consistent group Post-1993 acquisitions Cost of operations: Consistent group Post-1993 acquisitions Net operating income: Consistent group Post-1993 acquisitions Consistent group data: Gross margin Weighted average occupancy Average realized annual rent per square foot Number of facilities (at the end of the period): Consistent group Cumulative post-1993 acquisitions Net rentable square feet (at the end of the period): Consistent group Cumulative post-1993 acquisitions $14,685 8,891 23,576 7,260 3,490 10,750 7,425 5,401 $14,689 3,345 18,034 7,305 1,546 8.851 7,384 1,799 $12,826 $ 9,183 50.6% 96.0% $8.64 15 19 1,696 1,041 50.3% 96.3% $8.64 15 5 1,696 308 – 165.8% 30.7% (0.6)% 125.7% 21.5% 0.6% 200.2% 39.7% 0.6% (0.3)% – – 280.0% – 238.0% $14,689 3,345 18,034 $14,144 704 14,848 7,305 1,546 8.851 7,384 1,799 7,269 281 7,550 6,875 423 $ 9,183 $ 7,298 50.3% 96.3% $8.64 15 5 1,696 308 48.6% 95.0% $8.28 15 1 1,696 195 3.9% 375.1% 21.5% 0.5% 450.2% 17.2% 7.4% 325.3% 25.8% 3.4% 1.3% 4.4% – 400.0% – 57.9% As indicated in the above table, the Company’s commercial property operations have grown principally as a result of the addition of new prop- erties over the past three years. The operations of the consistent group of properties over the past three years has been relatively stable, with changes in operations principally the result of changing occupancy levels and realized rental rates. Due to the size of the Company’s investment in commercial properties relative to its self-storage facilities, the Company has not emphasized its growth in this segment of its portfolio. Effective January 2, 1997, the Company restructured its commercial property operations to concentrate its investing efforts in real estate facil- ities containing commercial and industrial rental space through a separate entity. See Note 14 to the consolidated financial statements. The Company believes that restructuring will create a vehicle which should facilitate future growth in this segment of the real estate industry. The Company will participate in this growth through its ownership interest in the new entity. The Company currently owns approximately 85% of the economic inter- est in the new entity. Accordingly, due to the Company’s significant ownership interest the Company will continue to consolidate the entity until such time that the Company’s ownership and control is reduced to a level not warranting consolidation. Equity in earnings of real estate entities: As of December 31, 1996, the Company had ownership interests in 41 affiliated limited partnerships and eight affiliated REITs which comprise the Unconsolidated Entities. The Company’s ownership interest in these entities ranges from 15% to 45%, but generally averages approximately 30%. Due to the Company’s limited ownership interest and control of these entities, the Company does not consolidate the accounts of these entities for financial reporting purposes. 30 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Equity in earnings of real estate entities represents the Company’s pro rata share of earnings of the Unconsolidated Entities using the equity method. Similar to the Company, the Unconsolidated Entities generate substantially all of their income from their ownership of self-storage facilities which are managed by the Company. In the aggregate, the Unconsolidated Entities own a total of 353 real estate facilities, 343 of which are self-storage facilities. The following table summarizes the components of the Company’s equity in earnings of real estate entities: Year Ended December 31, Year Ended December 31, (Amounts in thousands) Self-storage operations Commercial property operations Depreciation: Self-storage facilities Commercial properties Other(1) 1996 $ 41,722 2,667 (15,709) (1,741) (4,818) 1995 $ 6,573 269 (1,909) (136) (1,034) Dollar Change $ 35,149 2,398 (13,800) (1,605) (3,784) Total equity in earnings of real estate entities $ 22,121 $ 3,763 $ 18,358 (1)Principally the Company’s pro rata share of general and administrative expense and interest expense. 1995 $ 6,573 269 (1,909) (136) (1,034) $ 3,763 1994 $764 - - - - Dollar Change $ 5,809 269 (1,909) (136) (1,034) $764 $ 2,999 The increase in 1995 earnings compared to 1994 is principally the result of the acquisition of ownership interests in the Unconsolidated Entities acquired pursuant to the PSMI Merger. The increase in earnings in 1996 compared to 1995 is due to (i) the 1996 earnings reflect a full year’s oper- ations for those interests acquired in the PSMI Merger as opposed to just one and one-half months in 1995, (ii) the Company acquired additional interests during 1996 in the Unconsolidated Entities which resulted in increased earnings from these entities (See Note 5 to the Consolidated Finan- cial Statements) offset by (iii) certain business combinations occurring in 1996 whereby the Company’s existing ownership interest in certain entities was converted into wholly-owned real estate facilities (See Note 3 to the consolidated financial statements). The following table summarizes the combined operating data for fiscal 1996 with respect to those Unconsolidated Entities in which the Company had an ownership interest as of December 31, 1996: Rental income Total revenues Cost of operations Depreciation Net income $180,197,000 182,036,000 65,417,000 27,332,000 75,937,000 P R O P E R T Y M A N A G E M E N T O P E R A T I O N S In connection with the PSMI Merger, the Company acquired property management contracts, exclusive of facilities owned by the Company, for self-storage facilities and, through ownership of a 95% economic interest in a subsidiary, the management contracts for commercial properties. These facilities constitute all of the United States self-storage facilities and commercial properties doing business under the “Public Storage” name and all those in which the Company has an interest. At December 31, 1996, the Company managed 1,101 self-storage facilities (1,064 owned by affiliates of the Company and 37 owned by third parties) and 45 commercial properties, all of which are owned by affiliates of the Company. The property management contracts generally provide for compensation equal to 6%, in the case of the self-storage facilities, and 5%, in the case of the commercial properties, of gross revenues of the facilities managed. Under the supervision of the property owners, the Company coordinates rental policies, rent collections, marketing activities, the purchase of equipment and supplies, maintenance activity, and the selection and engage- ment of vendors, suppliers and independent contractors. In addition, the Company assists and advises the property owners in establishing policies for the hire, discharge and supervision of employees for the operation of these facilities, including resident managers, assistant managers, relief managers and billing and maintenance personnel. 31 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) PROPERTY MANAGEMENT OPERATIONS: Year Ended December 31, Year Ended December 31, (Amounts in thousands) Facility management fees: Self-storage Commercial properties Cost of operations: Self-storage Commercial properties Net operating income: Self-storage Commercial properties 1996 1995 $13,474 954 14,428 1,820 755 2,575 11,654 199 $11,853 $1,976 168 2,144 264 88 352 1,712 80 $1,792 Dollar Change $11,498 786 12,284 1,556 667 2,223 9,942 119 $10,061 1995 1994 $1,976 168 2,144 264 88 352 1,712 80 $1,792 $ $ – – – – – – – – – Dollar Change $1,976 168 2,144 264 88 352 1,712 80 $1,792 Because the Company has significant ownership interests in all but 37 of the facilities it manages, the revenues generated from its property man- agement operations are generally predictable and are dependent upon the future growth of rental income for those facilities the Company manages. However, because the Company has in the past, and may continue to seek to acquire in the future, real estate facilities owned by the Unconsolidated Entities, the Company’s facility management income should decrease in 1997 compared to 1996. The acquisitions of such facilities will reduce man- agement fee income. However, offsetting the reduction in management fee income will be a corresponding reduction in the cost of property opera- tions as the facilities acquired by the Company will no longer incur property management fees. A N C I L L A R Y B U S I N E S S E S Although not material to the Company’s overall operations, its ancillary business is expected to play a more important role in the future of the Company. The following table summarizes the Company’s ancillary business operations: Year Ended December 31, Year Ended December 31, (Amounts in thousands) Ancillary revenues: Sales of locks, boxes and packaging material Truck rental income Portable self-storage rents Cost of operations – ancillary business Locks, boxes and package materials Truck rentals Portable self-storage Net operating income (loss) – ancillary business Locks, boxes and package materials Truck rentals Portable self-storage 1996 1995 $2,540 543 421 3,504 1,660 511 1,247 3,418 880 32 (826) $101 11 – 112 84 16 – 100 17 (5) – Dollar Change $2,439 532 421 3,392 1,576 495 1,247 3,318 863 37 (826) 1995 1994 $ $101 11 – 112 84 16 – 100 17 (5) – – – – – – – – – – – – – Dollar Change $101 11 – 112 84 16 – 100 17 (5) – $ 12 $ 86 $ 12 $ 74 $ 12 $ 32 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T In an effort to attract a wider variety of customers, to further differentiate the Company from its competition and to generate new sources of revenues, additional businesses are being developed to complement the Company’s self-storage business. These products include the sale of locks, boxes and packing supplies and the rental of trucks and other moving equipment through the implementation of (i) a retail expansion program, (ii) truck rental program and more importantly (iii) a portable self-storage business. The strategic objective of the retail expansion program is to create a “Retail Store” that will (i) rent spaces for the attached self-storage facility, (ii) rent spaces for the other Public Storage facilities in adjacent neighborhoods, (iii) sell locks, boxes and packing materials to the general public, including tenants and (iv) rent trucks and other moving equipment, all in an environment that is more retail oriented. Retail stores will be retrofitted to existing self-storage facility rental offices or “built-in” as part of the development of new self-storage facilities, both in high traffic, high visibility locations. In 1996, the Company organized Public Storage Pickup & Delivery, Inc. (“PSPUD”) as a separate corporation to operate a portable self- storage business that rents storage containers to customers for storage in central warehouses and provides related transportation services. The Company believes PSPUD’s business complements the Company’s existing operations and PSPUD is using the national telephone reservation sys- tem and various marketing initiatives, including radio and television, to promote its rental activity. PSPUD currently operates a total of 12 facilities in six greater metropolitan areas in California and Texas. PSPUD anticipates opening four additional facilities in these areas and in three additional areas by the end of the first quarter of 1997. PSPUD presently anticipates expanding its operations to a significant number of additional areas dur- ing the remainder of 1997 and 1998, subject to continuing evaluation of this business and the satisfaction of regulatory requirements. There can be no assurance on the level of PSPUD’s expansion or profitability. Although not material to the Company’s 1996 operating results, the Company expects that this business will have a material impact on the Company during 1997 and beyond. Generally, PSPUD expects to expend an amount ranging from $850,000 to $1,100,000 per facility during the first full year of operations, depending on location and pricing structure. This estimate includes approximately $550,000 of capitalized expenditures and assumes (i) a leased facility for 2,000 storage containers, (ii) a break-even occupancy level of 55% to 65%, (iii) a stabilized occupancy level of 90% reached in 9 to 12 months, and (iv) monthly rental rates ranging from $35.00 to $45.00 per container. Rental rates will vary based on location and market conditions. Most of the operating costs of a facility are expected to be fixed. However, certain fixed costs are expected to be reduced as the facility reaches a stabilized occupancy level and certain economies of scale are expected to be achieved as the number of facilities in operation grows. PSPUD’s operating experience is limited and its operations may be affected by such factors as the level of competition in the business, the demand for storage containers, general economic conditions, either nationally or in the market areas in which PSPUD operates, the rate of facility move- ins and move-outs, the availability of acceptable locations, the level of PSPUD’s operating expenses and the cost of capital equipment. Until the facilities are operating profitably, PSPUD’s operations are expected to adversely impact the Company’s earnings growth rate. The extent of the impact will depend in significant part on the number, timing and performance of new facilities. O T H E R I N C O M E A N D E X P E N S E I T E M S Interest and other income: Interest and other income was $7,064,000 in 1996, $4,497,000 in 1995, and $4,587,000 in 1994. This income is pri- marily attributable to interest income on cash balances (as a result of uninvested net equity offering proceeds during 1996 and 1995) and interest income from mortgage notes receivable. The Company canceled approximately $700,000 in 1996, $16,435,000 in 1995, and $24,441,000 in 1996 of mortgage notes receivable in connection with the acquisition of real estate facilities securing such notes. The Company also acquired notes receiv- able of $6,667,000 in the PSMI Merger in 1995 and an additional $3,709,000 in 1996 from affiliated parties. As a result, interest income from mortgage notes receivable decreased from $4,333,000 in 1994 to $1,974,000 in 1995, as the average outstanding mortgage notes receivable balance was significantly lower. Interest income from the mortgage notes receivable increased from $1,974,000 in 1995 to $2,710,000 in 1996 as a result of the notes acquired in 1995 and 1996. 33 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) Depreciation and amortization: Depreciation and amortization expense was $64,967,000 in 1996, $40,760,000 in 1995, and $28,274,000 in 1994. These increases are principally due to the acquisition of additional real estate facilities in each period combined with amortization of intangible assets acquired in connection with the PSMI Merger. Depreciation expense with respect to the real estate facilities was $55,689,000 in 1996, $39,376,000 in 1995, and $28,099,000 in 1994; the increases are due to the acquisition of additional real estate facilities in 1994 through 1996. Amortization expense with respect to intangible assets acquired in the PSMI Merger totaled $9,309,000 in 1996 and $1,164,000 in 1995 (the 1995 amount representing a pro rated amount from November 16, 1995 through the end of the year). General and administrative expense: General and administrative expense was $5,524,000 in 1996, $3,982,000 in 1995, and $2,631,000 in 1994. The Company has experienced and expects to continue to experience increased general and administrative costs due to the following: (i) the growth in the size of the Company, (ii) the Company’s property acquisition activities have continued to expand, resulting in certain additional costs incurred in connection with the acquisition of additional real estate facilities, and (iii) pursuant to the PSMI Merger, the Company became self-advised, resulting in the Company internalizing management functions which previously were provided by the Company’s investment adviser. However, offsetting the expected increases in general and administrative expenses has been the elimination of advisory fee expense. General and adminis- trative costs for each year principally consist of state income taxes (for states in which the Company is a non-resident), investor relation expenses, and certain overhead associated with the acquisition and development of real estate facilities. Interest expense: Interest expense was $8,482,000 in 1996, $8,508,000 in 1995, and $6,893,000 in 1994. Reflecting the Company’s reluctance to finance its growth with debt, debt and related interest expense remains relatively low compared to the Company’s overall asset base. The decrease in interest expense in 1996 compared to 1995, principally is due to the early retirement of debt in 1996 of approximately $41.0 million having a weighted average interest rate of 7.76% partially offset by assumption of a $65.5 million, 7.08% unsecured senior note in connection with the PSMI Merger on November 16, 1995. Environmental costs: The Company’s policy is to accrue environmental assessments and/or remediation cost when it is probable that such efforts will be required and the related costs can reasonably be estimated. The majority of the Company’s real estate facilities were acquired prior to the time when it was customary to conduct environmental assessments. During 1995, the Company and the Consolidated Partnerships conducted inde- pendent environmental investigations of their real estate facilities. As a result of these investigations, the Company has recorded an amount which, in management’s best estimate, will be sufficient to satisfy anticipated costs of known remediation requirements. At December 31, 1995, the Company accrued $2,741,000 for estimated environmental remediation costs. Although there can be no assurance, the Company is not aware of any environmental contamination of any of its facilities which individually or in the aggregate would be material to the Company’s overall business, financial condition, or results of operations. The Company believes that amounts accrued in 1995 are sufficient to satisfy anticipated costs. Advisory fees: Advisory fees were $4,983,000 in 1994 and $6,437,000 in 1995. The advisory fee, which was based on a contractual computation, increased as a result of increased adjusted net income (as defined) per common share combined with the issuance of additional preferred and com- mon stock during each of the periods. Advisory fees for fiscal 1995 represent such amounts from the beginning of the year through November 16, 1995, when the Company became self-advised pursuant to the PSMI Merger. As a result of becoming self-advised, the Company no longer incurs advisory fees. Minority interest in income: Minority interest in income represents the income allocable to equity interests in the Consolidated Partnerships which are not owned by the Company. Since 1990, the Company has acquired portions of these equity interests through its acquisition of limited and gen- eral partnership interests in the Consolidated Partnerships. These acquisitions have resulted in reductions to the “Minority interest in income” from what it would otherwise have been in the absence of such acquisitions, and accordingly, have increased the Company’s share of the Consolidated Partnerships’ income. However, offsetting the reduction in minority interest in 1996 caused by the acquisition of additional equity interests are the inclusion of additional partnerships in the Company’s consolidated financial statements. During 1996, the Company acquired sufficient ownership interest and control in three partnerships and commenced including the accounts of these partnerships in the Company’s consolidated financial statements which amounted to an increase in minority interest in income of approximately $2,187,000 in 1996. In determining income allocable to the minority interest for 1996, 1995 and 1994 consolidated depreciation and amortization expense of approx- imately $11,490,000, $11,243,000 and $13,556,000, respectively, was allocated to the minority interest. The decrease in depreciation allocated to the minority interest was principally the result of the acquisition of limited partnership units in the Consolidated Partnerships by the Company throughout fiscal 1994, 1995 and 1996 offset by an increase in 1996 resulting from the above mentioned consolidation of three partnerships. 34 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T S U P P L E M E N T A L P R O P E R T Y D A T A A N D T R E N D S There are approximately 81 ownership entities owning in aggregate 1,064 self-storage facilities, including the facilities which the Company owns and/or operates. At December 31, 1996, 343 of these facilities were owned by Unconsolidated Entities, entities in which the Company has an owner- ship interest and uses the equity method for financial statement presentation. The remaining 721 facilities are owned by the Company and Consolidated Partnerships, many of which were acquired through business combinations with affiliates during 1996, 1995, and 1994. In order to evaluate how the Company’s overall portfolio has performed, management analyzes the operating performance of a consistent group of self-storage facilities representing 951 (55.8 million net rentable square feet) of the 1,064 self-storage facilities (herein referred to as “Same Store” self-storage facilities) which have been operated under the “Public Storage” name for at least the past three years. The Same Store group of properties includes 613 consolidated facilities and 338 facilities owned by Unconsolidated Entities. The following table summarizes the pre-depreciation historical operating results of the Same Store self-storage facilities: SAME-STORE MINI-WAREHOUSE FACILITIES: (Historical property operations) (Dollar amounts in thousands, except rent per square foot) 1996 1995 Change 1995 1994 Change Year Ended December 31, Year Ended December 31, Rental income Cost of operations(1) Net operating income Gross profit margins(3) Weighted avg. occupancy Weighted avg. realized rent per sq. ft.(2) Weighted avg. scheduled annual rent per sq. ft.(2) $445,586 158,212 $287,374 64.5% 91.2% $8.76 $9.00 $422,933 149,660 $273,273 64.6% 90.1% $8.40 $8.16 5.4% 5.7% 5.2% (0.2)% 1.2% 4.3% 10.3% $422,933 149,660 $273,273 64.6% 90.1% $8.40 $8.16 $403,295 144,752 $258,543 64.1% 89.2% $8.16 $7.80 4.9% 3.4% 5.7% 0.8% 1.0% 2.9% 4.6% 1. Assumes payment of property management fees on all facilities, including those facilities owned by the Company which effective November 16, 1995 no fee is paid. Cost of operations consists of the following: Payroll expense Property taxes Property management fees Advertising Telephone center costs Other(4) 1996 $ 43,490 40,799 26,139 3,851 1,956 41,977 $158,212 1995 $ 42,545 38,325 25,391 3,502 – 39,897 $149,660 1994 $ 41,092 36,941 24,214 3,709 – 38,796 $144,752 2. Realized rent per square foot represents the actual revenue earned per occupied square foot. Management believes this is a more relevant measure than the scheduled rental rates, since scheduled rates can be discounted through the use of promotions. 3. Gross profit margin is computed by dividing property net operating income (before depreciation expense) by rental revenues. Cost of operations include a 6% management fee. The gross profit margin excluding the facility management fee was 70.5%, 70.6% and 70.1% in 1996, 1995 and 1994, respectively. On November 16, 1995, the Company acquired its facility manager and no longer incurs such fees on the properties it owns. 4. Other expenses principally include utilities, repairs and maintenance, and other items such as office expenses. As indicated above, in early 1996, the Company implemented a national telephone reservation system designed to provide added customer ser- vice for all the self-storage facilities under management by the Company. The Company believes that the improved operating results, as indicated in the above table, in large part are due to the success of the national telephone reservation system. However, the national telephone reservation system was not fully operational for most of the self-storage facilities until the latter part of the fourth quarter of 1996. As of December 31, 1996, the national telephone reservation system was supporting rental activity at all of the self-storage properties managed by the Company, with the exception of one major market, which will be operational by end of March 1997. Rental income for the Same Store facilities included promotional discounts totaling $6,000,000 in 1996 ($3,000,000 of which occurred during the fourth quarter of 1996) compared to $729,000 and $1,466,000 in 1995 and 1994, respectively. The significant increase in 1996 was principally due to experimentation with pricing and promotional discounts designed to increase rental activity. In addition to evaluating property operating trends in occupancy, realized rents, expenses and net operating income on a Same Store basis, man- agement evaluates trends by geographic regions. Operating trends for the Same-Store facilities for the five largest regions are shown in the table on the following page. 35 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) SAME-STORE OPERATING TRENDS BY REGION Northern California Southern California % change from prior year Amount % change from prior year Amount Rental Revenues: 1996 1995 1994 $65,222 60,053 56,777 8.61% 5.77% 4.40% $79,524 75,826 73,191 4.88% 3.60% 6.73% Cost of operations: 1996 1995 1994 $18,457 17,856 17,271 Net operating income: 3.37% 3.39% 5.68% $24,580 23,250 23,633 5.72% (1.62)% 5.52% Texas % change from prior year 1.31% 2.69% 4.32% 5.83% 1.51% 9.35% Amount $39,704 39,191 38,163 $16,482 15,574 15,342 1996 1995 1994 $46,765 10.83% 6.81% 42,197 3.85% 39,506 $54,944 52,576 49,558 4.50% 6.09% 7.39% $23,222 23,617 22,821 (1.67)% 3.49% 1.19% Florida Illinois Other states % change from prior year Amount % change from prior year Amount % change from prior year Amount $27,908 27,066 26,241 $10,772 10,412 10,303 $17,136 16,654 15,938 3.11% 3.14% 3.45% 3.46% 1.06% 4.03% 2.89% 4.49% 3.09% 9.00% $31,123 7.67% 28,552 26,518 12.64% $202,105 192,245 182,405 $14,887 5.47% 14,115 16.94% 0.32% 12,070 $73,034 68,453 66,133 5.13% 5.39% 9.94% 6.69% 3.51% 4.19% $16,236 12.46% 14,437 (0.08)% 14,448 25.51% 4.26% $129,071 123,792 6.47% 116,272 13.51% Total % change from prior year 5.35% 4.87% 7.73% 5.71% 3.39% 4.76% 5.16% 5.70% 9.47% Amount $445,586 422,933 403,295 $158,212 149,660 144,752 $287,374 273,273 258,543 Weighted avg. occupancy: 1996 1995 1994 94.5% 3.73% 91.1% 3.52% 88.0% 0.57% 87.3% 2.46% 85.2% 2.40% 83.2% 3.35% 89.6% 1.36% 88.4% – 88.4% 1.61% 88.7% 0.23% 88.5% (1.34)% 89.7% (1.32)% 92.8% – 92.8% 1.98% 91.0% 7.44% 92.2% 0.55% 91.7% 0.33% 91.4% 2.81% 91.2% 1.22% 90.1% 1.01% 89.2% 2.53% Weighted avg. realized rents per sq. ft.: $10.20 9.72 9.48 4.94% 2.53% 2.60% 1996 1995 1994 $10.32 10.08 9.96 2.38% 1.20% 3.75% $6.84 6.84 6.72 – 1.79% 3.70% $8.04 7.80 7.44 3.10% 4.84% 3.33% $8.88 8.16 7.80 8.82% 4.62% 4.84% $8.40 8.04 7.68 4.48% 4.69% 6.67% $8.76 8.40 8.16 4.29% 2.94% 6.25% Factors affecting regional trends in revenues and expenses include: • acts of nature, including the Northridge earthquake (Southern California, 1994). • new competition from property development (Texas) • property valuations and related reassessments for purposes of property taxes (Illinois, 1995) These factors have and are expected to continue to affect regional operating trends. During 1997, management expects additional property tax assessments due to higher valuations/rates, resulting in increased property taxes. L I Q U I D I T Y A N D C A P I T A L R E S O U R C E S The Company has operated and intends to continue to operate in a self-sufficient manner without reliance on external sources of financing to fund its ongoing operating needs. The Company believes that funds internally generated from ongoing operations will continue to be sufficient to enable it to meet its operating expenses, capital improvements, debt service requirements and distributions to shareholders for the foreseeable future. Internally generated cash flows: The Company believes that important measures of its performance as well as its liquidity are cash provided by operations, funds from operations (“FFO”) and the ability of these measures to fund the Company’s operating requirements (i.e. capital improve- ments, principal payments on debt, and distribution requirements). Net cash provided by operating activities (as determined in accordance with generally accepted accounting principles) reflects the cash gener- ated from the Company’s business before distributions to various equity holders, including the preferred shareholders, capital expenditures or mandatory principal payments on debt. Net cash provided by operations has increased over the past three years from $79.2 million in 1994 to $245.2 million in 1996. 36 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Operating as a REIT, the Company’s ability to retain cash flow for reinvestment is restricted. In order for the Company to maintain its REIT status, a substantial portion of its operating cash flow must be used to make distributions to its shareholders (see “REIT status” below). Remaining cash flow must then be sufficient to fund necessary capital improvements and scheduled debt service requirements. The following table summarizes the Company’s ability to pay the minority interests’ distributions, its dividends to the preferred shareholders and capital improvements to maintain the facilities through the use of cash provided by operating activities. The remaining cash flow is available to the Company to make both scheduled and optional principal payments on debt, pay distributions to common shareholders and for reinvestment. (In thousands) Net income Depreciation and amortization Depreciation from Unconsolidated Entities Minority interest in income Environmental accrual Amortization of discounts on mortgage notes receivable Net cash provided by operating activities Distributions from operations to minority interests Cash from operations/ FFO allocable to the Company’s shareholders Less: preferred stock dividends Cash from operations/ FFO available to common shareholders Capital improvements to maintain facilities: Self-storage facilities Commercial properties Add back: minority interest share of capital improvements to maintain facilities Funds available for principal payments on debt, common dividends and reinvestment Cash distributions to common shareholders For the Year Ended December 31, 1996 1995 1994 $153,549 64,967 17,450 9,363 – (92) 245,237 (20,853) 224,384 (68,599) 155,785 (15,957) (4,409) 3,159 138,578 (67,709) $ 70,386 40,760 2,045 7,137 3,251 (113) 123,466 (18,380) 105,086 (31,124) 73,962 (8,509) (2,852) 3,219 65,820 (38,586) $ 42,118 28,274 – 9,481 – (693) 79,180 (23,037) 56,143 (16,846) 39,297 (6,360) (1,952) 2,948 33,933 (21,249) Funds available for principal payments on debt and reinvestment $ 70,869 $ 27,234 $ 12,684 See the Consolidated Statements of Cash Flows for the each of the three years in the period ended December 31, 1996 for additional informa- tion regarding the Company’s investing and financing activities. Total FFO increased to $224,384,000 for the year ended December 31, 1996 compared to $105,086,000 in 1995 and $56,143,000 in 1994. FFO available to common shareholders (after deducting preferred stock dividends) increased to $155,785,000 for the year ended December 31, 1996 compared to $73,962,000 in 1995 and $39,297,000 in 1994. FFO means net income (loss) (computed in accordance with generally accepted accounting principles) before (i) gain (loss) on early extinguishment of debt, (ii) minority interest in income and (iii) gain (loss) on disposition of real estate, adjusted as follows: (i) plus depreciation and amortization (including the Company’s pro-rata share of depreciation and amortization of unconsolidated equity interests and amortization of assets acquired in the PSMI Merger, including property management agreements and goodwill), and (ii) less FFO attributable to minority interest. FFO is a supplemental performance measure for equity REITs as defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”). The NAREIT definition does not specifically address the treatment of minority interest in the determination of FFO or the treatment of the amortization of property management agreements and goodwill. In the case of the Company, FFO represents amounts attributable to its share- holders after deducting amounts attributable to the minority interests and before deductions for the amortization of property management agree- ments and goodwill. FFO is presented because many industry analysts consider FFO to be one measure of the performance of the Company and it is used in establishing the terms of the Class B Common Stock. FFO does not take into consideration capital improvements, scheduled principal pay- ments on debt, distributions and other obligations of the Company. Accordingly, FFO is not a substitute for the Company’s cash flow or net income (as discussed above) as a measure of the Company’s liquidity or operating performance. The Company accounts for the Unconsolidated Entities using the equity method of accounting, and, accordingly, earnings are recognized based upon the Company’s interest in each of the partnerships and REITs. This interest is based on the Company’s share of the increase or decrease in the net assets of the entities from their operations. Provisions of the partnerships’ and REITs’ governing documents provide for the payment of pre- ferred cash distributions to other investors (until certain specified amounts have been paid) without regard to the pro-rata interest of all investors in current earnings. As a result, actual cash distributions paid to the Company for a period of time will be less than the Company’s interest in the entities’ FFO. During 1996, FFO distributed to the Company was approximately $16.4 million less than the Company’s share of FFO. Preferred cash distributions paid to other investors during each period have the effect of increasing the Company’s economic interest in each of the respective enti- 37 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued) ties and reducing the amount of future preference payments which must be paid to other investors before cash distributions will be shared on a pro- rata basis with respect to each investor’s actual interest. The aggregate future preference payments to other investors is approximately $81.1 mil- lion and is expected to be paid over approximately 12 years, with approximately 50% of the amount being paid over the next 3.5 years. Distributions requirements: Over the past four years, the Company’s conservative distribution policy has been the principal reason for the Company’s ability to retain significant operating cash flows which have been used to make additional investments and debt reductions. During 1994, 1995 and 1996, the Company distributed to common shareholders approximately 54%, 52% and 44% of its FFO available to common shareholders, respectively, allowing it to retain approximately $110.8 million over this period of time after satisfying its capital improvements and preferred stock dividend requirements. During 1996, the Company paid dividends totaling $56,472,000 to the holders of the Company’s Senior Preferred Stock, $12,127,000 to the hold- ers of the Convertible Preferred Stock, and $67,709,000 to the holders of Common Stock. Dividends with respect to the Senior Preferred Stock and the Convertible Preferred Stock include pro-rated amounts for securities issued during 1996. The Company estimates the distribution requirements for fiscal 1997 with respect to Senior Preferred Stock and the Convertible Preferred Stock to be approximately $76.8 million. Distributions with respect to the common stock will be determined based upon the Company’s REIT distribution requirements after taking into consideration distrib- utions to the Company’s preferred shareholders. Capital improvement requirements: During 1997, the Company has budgeted approximately $26.6 million for capital improvements ($22.4 mil- lion for its self-storage facilities and $4.2 million for its commercial properties). The minority interests’ share of the budgeted capital improvements is approximately $3.3 million. During 1995, the Company commenced a program to enhance its visual icon and modernize the appearance of its self-storage facilities, includ- ing modernization of signs, paint color schemes, and rental offices. Included in the 1997 capital improvement budget is approximately $4.8 million with respect to these expenditures. The significant increase in capital improvements in 1996 for the self-storage facilities (as reflected in the table on page 37) is due to the acqui- sition of new facilities in 1996 and 1995 and the aforementioned visual enhancements during 1996. Debt service requirements: The Company does not believe it has any significant refinancing risks with respect to its mortgage debt, all of which is fixed rate. During 1996, the Company retired early approximately $43.2 million of mortgage debt. At December 31, 1996, the Company had total outstanding borrowings of approximately $108.4 million. See Note 8 to the Consolidated Financial Statements for approximate principal maturities of such borrowings. The Company uses its $150.0 million of bank credit facility (all of which was unused as of March 18, 1997) primarily to fund acquisitions and provide financial flexibility and liquidity. The credit facility currently bears interest at LIBOR plus 0.40% based on the Company’s current financial ratios. Growth strategies: During 1997, the Company intends to continue to expand its asset and capital base principally through the (i) acquisition of real estate assets and interests in real estate assets from both unaffiliated and affiliated parties through direct purchases, mergers, tender offers or other transactions, (ii) development of additional self-storage facilities and (iv) the expected growth in the operations of PSPUD in the portable self-stor- age business. See further discussion below with respect to each of these activities. The Company expects to fund these transactions with internally generated retained cash flows and borrowings under its $150.0 million credit facility. The Company intends to repay amounts borrowed under the credit facility from undistributed operating cash flow or, as market conditions permit and are determined to be advantageous, from the public or private placement of equity securities. With respect to the development of addi- tional self-storage facilities, the Company expects to enter into a joint venture arrangement, see “Development Activities” below. External financing ability: The Company believes that its size and financial flexibility enables it to access capital for growth when appropriate. The Company’s financial profile is characterized by a low level of debt to total capitalization, increasing net income, increasing cash flow from opera- tions, and a conservative dividend payout ratio with respect to the common stock. The Company’s credit ratings on its Senior Preferred Stock by each of the three major credit agencies are Baa2 by Moody’s and BBB+ by Standard and Poors and Duff & Phelps. The Company’s portfolio of real estate facilities remains substantially unencumbered. At December 31, 1996, the Company had mortgage debt outstanding of $48.7 million and had consolidated real estate facilities with a book value of $1.9 billion. The Company, however, has been reluctant to finance its acquisitions with debt and generally will only increase its mortgage borrowing through the assumption of pre-existing debt on acquired real estate facilities. 38 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Over the past three years the Company has funded substantially all of its acquisitions with permanent capital (both common and preferred stock). Unlike many other real estate companies, the Company has elected to use preferred stock despite the fact that the coupon rates of its preferred stock exceeds current rates on conventional debt. The Company has chosen this method of financing for the following reasons: (i) the Company’s perpetual preferred stock has no sinking fund requirements or maturity date and does not require redemption, all of which eliminate any future refinancing risks, (ii) preferred stock allows the Company to leverage the common stock without the attendant interest rate or refinancing risks of debt, and (iii) dividends on the preferred stock can be applied to the Company’s REIT distributions requirements, which have helped the Company to maintain a low common stock dividend payout ratio and retain cash flow. On March 18, 1997, the Company publicly issued 4.6 million shares of common stock, raising net proceeds of approximately $126.5 million. The Company intends to use the net proceeds from this offering to make investments in real estate, primarily self-storage, including mortgage loans and interest in real estate partnerships, to satisfy cash elections in connection with mergers with affiliated REITs and to fund expenditures of PSPUD. Proposed mergers with affiliates: In December 1996, Public Storage Properties XIV, Inc. (“Properties 14”) and Public Storage Properties XV, Inc. (“Properties 15”) each agreed, subject to certain conditions, to merge with and into the Company. Properties 14 and Properties 15 are affiliated, publicly traded equity REITs. Each of the mergers is conditioned on approval by the respective shareholders of Properties 14 and Properties 15. However, the mergers are not conditioned on each other. The Company expects that if approved by the shareholders, the mergers would be com- pleted in April 1997. The estimated value of the Properties 14 and Properties 15 merger is approximately $63.8 million and $58.5 million, respec- tively. Properties 14 and Properties 15 own 14 properties (912,000 square feet) and 19 properties (1,087,000 square feet), respectively. The Company currently owns approximately 33% and 35% of the economic interest in Properties 14 and Properties 15, respectively. Development activities: At December 31, 1996, the Company had eleven self-storage facilities (approximately 707,000 square feet) under con- struction with an aggregate cost incurred to date of approximately $33.5 million and total additional estimated cost to complete of $22.5 million. The Company currently has plans to develop an additional 17 self-storage facilities (approximately 1,026,000 square feet) in various locations at an estimated cost of approximately $70.2 million. The Company is evaluating the feasibility of developing additional self-storage facilities in selected markets in which there are few, if any, facilities to acquire at attractive prices and where the scarcity of other undeveloped parcels of land or other impediments to development make it difficult to construct additional competing facilities. The Company has reached an agreement in principle with a joint venture partner to participate in funding the development of approximately $220 million of self-storage facilities (including the facilities currently under development by the Company). The joint venture partner would contribute about 70% of the venture’s capital with the balance provided by the Company. After a period of time, the Company would have an option to acquire the other venturer’s interest. There can be no assurance that a definitive agreement can be reached between the Company and the joint venturer partner. Assuming an agreement is finalized, it is expected that the joint venture would be funded in early April 1997. Portable self-storage business: As indicated above, in 1996 the Company organized PSPUD as a separate corporation to operate a portable self- storage business that rents storage containers to customers for storage in central warehouses and provides related transportation services. PSPUD currently operates a total of 12 facilities in six greater metropolitan areas in California and Texas and anticipates opening four additional facilities in these areas and in three additional areas by the end of the first quarter of 1997. PSPUD presently anticipates expanding its operations to a sig- nificant number of additional areas during the remainder of 1997 and 1998, subject to continuing evaluation of this business and the satisfaction of regulatory requirements. There can be no assurance on the level of PSPUD’s expansion or profitability. Generally, PSPUD expects to expend an amount ranging from $850,000 to $1,100,000 per facility during the first full year of operations, depend- ing on location and pricing structure. This estimate includes approximately $550,000 of capitalized expenditures combined with estimated first year operating losses and is based on certain assumptions indicated under “Ancillary Businesses” (pages 32-33). REIT status: The Company believes that it has operated, and intends 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 it will at all times so qualify. To the extent that the Company continues to qualify as a REIT, it will not be taxed, with certain limited exceptions, on the taxable income that is distributed to its shareholders. As a REIT, the Company is not taxed on that portion of its taxable income which is distributed to its shareholders provided that at least 95% of its taxable income is so distributed prior to filing of the Company’s tax return. The Company has satisfied the REIT distribution requirement since 1980. 39 P U B L I C S T O R A G E , I N C . 1 9 9 6 A N N U A L R E P O R T Common Stock Distribution Policy and Stock Price Public Storage, Inc. has paid continuous quarterly distributions to its shareholders since 1981, its first full year of operations. Distributions paid per share of common stock for 1996 amounted to $.88. Holders of common stock are entitled to receive distributions when and if declared by the Company’s Board of Directors out of any funds legally available for that purpose. The Company is required to distribute at least 95% of its net taxable ordinary income prior to the filing of the Company’s tax return and 85%, subject to certain adjustments, during the calendar year, to maintain its REIT status for Federal income tax purposes. It is management’s intention to pay distributions of not less than this required amount. For Federal tax purposes, distributions to shareholders are treated as ordinary income, capital gains, return of capital or a combination thereof, and for the past three years distributions to common share- holders were as follows: Year Ended 1996 1995 1994 Amount Paid $.88 .88 .85 Ordinary Income $.88 .88 .85 Capital Gain Amount Non-taxable Return of Capital $ – – – $ – – – The common stock has been listed on the New York Stock Exchange since October 19, 1984 and on the Pacific Exchange since December 26, 1996. The ticker symbol is PSA. The following table sets forth the high and low sales prices of the common stock on the New York Stock Exchange composite tapes for the applic- able periods. Year 1995 1996 Quarter 1st 2nd 3rd 4th 1st 2nd 3rd 4th Range Low $131⁄2 151⁄4 163⁄8 173⁄8 187⁄8 193⁄8 197⁄8 221⁄4 High $171⁄8 171⁄8 183⁄4 193⁄4 217⁄8 211⁄2 225⁄8 313⁄8 As of February 28, 1997, there were approximately 19,676 holders of record of the common stock. 40 Corporate Data Public Storage, Inc. http:// w w w.publicstorage.com D I R E C T O R S E x e c u t i v e O f f i c e r s O t h e r C o r p o r a t e O f f i c e r s M a n a g e m e n t D i v i s i o n B. Wayne Hughes (1980) Chairman of the Board and Chief Executive Officer B. Wayne Hughes Chairman of the Board and Chief Executive Officer Harvey Lenkin (1991) President Harvey Lenkin President Robert J. Abernethy (1980) President, American Standard Development Company and Self-Storage Management Company Dann V. Angeloff (1980) President, The Angeloff Company William C. Baker (1991) Chairman and Chief Executive Officer of Santa Anita Operating Company and Chairman of Santa Anita Realty Enterprises, Inc. Uri P. Harkham (1993) President and Chief Executive Officer of the Jonathan Martin Fashion Group Date in parentheses indicates year director was elected to the board. Shareholders may obtain, without charge, a copy of Form 10-K, as filed by the Company with the Securities and Exchange Commission by addressing a written request to the Investor Services Department at the Corporate Headquarters. Printed in USA: Costello Brothers Lithographers, Alhambra, California John Reyes Senior Vice President, Chief Financial Officer and Assistant Secretary Hugh W. Horne Senior Vice President Marvin M. Lotz Senior Vice President David Goldberg Senior Vice President and General Counsel A. Timothy Scott Senior Vice President and Tax Counsel Obren B. Gerich Senior Vice President and Assistant Secretary Sarah Hass Vice President and Secretary American Office Park Properties, Inc. Ronald L. Havner, Jr. President and Chief Executive Officer Mary Jayne Howard Executive Vice President President-Operations Group Mary Piper-Mutz Vice President Lee Rippel Vice President Samuel I. Ballard Vice President Anthony Grillo Vice President Alan Grossman Vice President Tamara Hughes Gustavson Vice President - Administration Joanne A. Halliday Vice President Ronald L. Harden, Sr. Vice President Gregory S. Houge Vice President B. Wayne Hughes, Jr. Vice President - Acquisitions Brent C. Peterson Vice President and Chief Information Officer David P. Singelyn Vice President, Treasurer and Assistant Secretary Jill L. Webster Vice President and Director of Taxation P R O F E S S I O N A L S E R V I C E S Transfer Agent Boston EquiServe Boston, Massachusetts http://www.EquiServe.com Auditors Ernst & Young LLP Los Angeles, California Marvin M. Lotz President Samuel I. Ballard Senior Vice President Anthony Grillo Senior Vice President Ronald L. Harden, Sr. Senior Vice President Gregory S. Houge Senior Vice President Brent C. Peterson Senior Vice President Timothy C. Arthurs Vice President Ira J. Bailey Vice President Kelly M. Barnes Vice President Jeffery A. Biesz Vice President Brad A. Boyd Vice President Richard J. Gerner Vice President Alan Grossman Vice President Les Guttman Vice President Joanne A. Halliday General Counsel Kay Merg Vice President Thomas O. Murphy Vice President Gary P. Ott Vice President Brian J. Ruthsatz Vice President John M. Sambuco Vice President Kathleen Steele Vice President James Stevens Vice President Daniel M. Yoshihara Vice President Public Storage, Inc. 701 Western Avenue Glendale, California 91201 (818) 244-8080 Address Correction Requested www.publicstorage.com Bulk Rate U.S. Postage PAID Bank of Boston 

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