ITEM 1. BUSINESS
General
Sovran Acquisition Limited Partnership (the "Operating Partnership") is the entity through which Sovran Self Storage, Inc. (the "Company"), a self-administered and self-managed real estate investment trust ("REIT"), conducts substantially all of the Company's business and owns substantially all of the Company's assets. The Operating Partnership is one of the largest owners and operators of self-storage properties in the Eastern United States and Texas. In 1995, the Company was formed under Maryland law and the Operating Partnership was organized as a Delaware limited partnership to continue and to expand the self-storage operations of the Company's privately owned predecessor organizations. The term "Company Predecessors" as used herein refers to the Company's predecessor organizations prior to the Company's initial public offering in June, 1995 (the "Initial Offering") and the concurrent completion of the various transactions that occurred simultaneously therewith (the "Formation Transactions"). The term "Company" as used herein means Sovran Self Storage, Inc. and its subsidiaries on a consolidated basis (including the Operating Partnership) or, where the context so requires, Sovran Self Storage, Inc. only, and, as the context may require, the Company Predecessors. The term "Operating Partnership" as used herein means Sovran Acquisition Limited Partnership and, as the context may require, the Company Predecessors.
The Company is currently a 93.45% economic owner of the Operating Partnership and controls it through Sovran Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of the Company incorporated in Delaware and the sole general partner of the Operating Partnership. This structure is commonly referred to as an umbrella partnership REIT or "UPREIT". The Board of Directors of Holdings, the members of which are the same as the members of the Board of Directors of the Company, manages the affairs of the Operating Partnership by directing the affairs of Holdings. The Company's limited partner and indirect general partner interests in the Operating Partnership entitle it to share in cash distributions from, and in the profits and losses of, the Operating Partnership in proportion to its ownership interest therein and entitle the Company to vote on all matters requiring a vote of the limited partners.
The other limited partners of the Operating Partnership are persons who contributed their direct or indirect interests in certain self-storage properties to the Operating Partnership. The Operating Partnership is obligated to redeem each unit of limited partnership ("Unit") at the request of the holder thereof for cash equal to the fair market value of a share of the
Company's common stock, par value $.01 per share ("Common Shares"), at the time of such redemption, provided that the Company at its option may elect to acquire any such Unit presented for redemption for one Common Share or cash. With each such redemption or acquisition by the Company, the Company's percentage ownership interest in the Operating Partnership will increase. In addition, whenever the Company issues Common Shares, the Company is obligated to contribute any net proceeds therefrom to the Operating Partnership and the Operating Partnership is obligated to issue an equivalent number of Units to the Company.
The Operating Partnership may issue additional Units to acquire additional self-storage properties in transactions that in certain circumstances defer some or all of the sellers' tax consequences. The Operating Partnership believes that many potential sellers of self-storage properties have a low tax basis in their properties and would be more willing to sell the properties in transactions that defer Federal income taxes. Offering Units instead of cash for properties may provide potential sellers partial Federal income tax deferral.
As of March 25, 1999 the Operating Partnership owned and operated 211 self-storage properties (individually, a "Property" and collectively, the "Properties") consisting of approximately 11.8 million net rentable square feet, situated in 19 states, primarily the Eastern United States and Texas. As of December 31, 1998, the Properties had a weighted average occupancy of 86.4% and a weighted average annual rent per occupied square foot of $7.69. The Operating Partnership believes that it is the 5th largest operator of self-storage properties in the United States based on facilities owned.
The Operating Partnership seeks to increase cash flow and enhance investor value through aggressive management of the Properties and selective acquisitions of new self-storage properties. Aggressive property management entails increasing rents, increasing occupancy levels, strictly controlling costs, maximizing collections, strategically expanding and improving the Properties and, should economic conditions warrant, developing new properties. The Operating Partnership believes that there continues to be significant opportunities for growth through acquisitions, and constantly seeks to acquire self-storage properties located primarily in the Eastern United States that are susceptible to realization of increased economies of scale and enhanced performance through application of the Operating Partnership's management expertise.
The Operating Partnership's principal executive offices are located at 5166 Main Street, Williamsville, New York 14221, and its telephone number is (716) 633-1850.
Industry Overview
The Operating Partnership believes that self storage facilities offer inexpensive storage space to residential and commercial users. In addition to fully enclosed and secure storage space, some operators, including the Operating Partnership, also offer outside storage for automobiles, recreational vehicles and boats. The storage sites are usually fenced and well lighted with gates that are either manually operated or automated. All facilities have a full time manager/leasing agent. Customers have access to their storage area during business hours and in certain circumstances are provided with 24 hour access. Individual storage units are secured by the customer's lock, which may be purchased from the Operating Partnership, and the customer has control of access to the unit.
The Operating Partnership believes that the self-storage industry is characterized by a trend toward consolidation, continuing increase in demand, relatively slow growth in supply and a targeted market of primarily residential customers.
According to published data, of the approximately 26,000 facilities in the United States, less than 18% are managed by the ten largest operators. The remainder of the industry is characterized by numerous small, local operators. The shortage of skilled operators, the scarcity of financing available to small operators for acquisitions and expansions and the potential for savings through economies of scale are factors which are leading to a consolidation in the industry. The Operating Partnership believes that as a result of this trend, significant growth opportunities exist for operators with proven management systems and sufficient capital resources.
The self-storage industry has also experienced relatively slow growth in supply in recent years due to the scarcity of financing available to small operators, restrictive zoning and other regulations and the substantial start up costs associated with the construction and lease-up of new facilities. Demand for self-storage service has increased as indicated by an increase in industry-wide average rents and in industry average occupancy. It is expected to remain strong because it is slow to react to changing conditions and because of various other factors, including population growth, increased mobility, expansion of condominium, townhouse and apartment living, and increasing consumer awareness, particularly by commercial users. Commercial customers tend to rent larger areas for longer terms, are more reliable payers and are less sensitive to price increases. The Operating Partnership estimates that commercial users account for approximately 30-35% of its total occupancy, which is substantially higher than the reported industry average of 23%.
Property Management
The Operating Partnership believes that it has developed substantial expertise in managing self-storage facilities. Key elements of the Operating Partnership's management system include:
- - - Recruiting, training and retaining capable, aggressive on- site Property Managers;
- - - Motivating Property Managers by providing incentive-based compensation;
- - - Developing and maintaining an integrated marketing plan for each Property;
- - - Minimizing maintenance costs;
- - - Linking all facilities to a central customized management information system; and
- - - Utilization of a national marketing program that attracts commercial tenants who have multi market self-storage needs.
Each Property is generally managed by a full-time Property Manager and one or more assistant managers. Each Property Manager is responsible for most operational decisions with respect to his or her Property, including rent charges and maintenance, subject to certain monetary limits. Assistant managers enable Property Managers to have sufficient time to perform marketing functions. Each Property Manager reports to an Area Manager who in turn reports to a Regional Vice President. The Operating Partnership currently employs four Regional Vice Presidents who primarily focus on marketing and overall supervision of the Area Managers. The Area Managers are responsible for overseeing site operations.
Property Managers attend a thorough orientation program and undergo continuous training which emphasizes telephone skills, closing techniques, identification of selected marketing opportunities, networking with possible referral sources, and familiarization with the Operating Partnership's customized management information system. In addition to frequent contact with Area Managers and other Operating Partnership personnel, Property Managers receive periodic newsletters regarding a variety of operational issues, and from time to time attend "roundtable" seminars with other Property Managers.
The Operating Partnership annually develops a written marketing plan for each of its Properties the content of which is highly dependent upon local conditions. The focus of each marketing plan is, in part, determined by occupancy rates. If all storage units of a same size at a Property are at or near 90% occupancy, then the plan will generally include increases in rental rates. If a Property has excess capacity, then the marketing plan will target selected markets such as local military bases, colleges, apartment and condominium complexes, industrial parks, medical centers, retail shopping malls and office suites. The Operating Partnership primarily uses telephone directories to advertise its services, including a map and when possible, listing Properties in the same marketplace in a single advertisement. The Operating Partnership also conducts quarterly surveys of its competitors' practices, which include "shopping" competing facilities.
The Operating Partnership's customized computer system performs billing, collections and reservation functions for each Property, and also tracks information used in developing marketing plans based on occupancy levels, and tenant demographics and histories. The system generates daily, weekly and monthly financial reports for each Property that are immediately transmitted to the Operating Partnership's principal office each night. The system also requires a Property Manager to input a descriptive explanation for all debit and credit transactions, paid-to-date changes, and all other discretionary activities, which allows the accounting staff at the Operating Partnership's principal office to promptly review all such transactions. Late charges are automatically imposed. More sensitive activities such as rental rate changes and unit size or number changes are completed only by Area Managers. The Operating Partnership's customized management information system permits it to add new facilities to its portfolio with minimal additional overhead expense.
The Operating Partnership's Regional Vice Presidents, Area Managers and Property Managers are compensated with a base salary and may, in addition, earn incentive compensation. The Operating Partnership annually establishes a target gross income and net operating income for each Property. As incentive compensation, Property Managers earn a percentage of all gross income in excess of the target level; and Regional Vice Presidents earn a percentage of the combined net operating incomes in excess of the targeted levels for all facilities reporting to them. The Area Managers may receive bonuses from the Regional Vice President they work under. This incentive compensation program is not subject to any caps or increment requirements. It is not unusual for any manager to earn in excess of 10% of the base salary as incentive compensation. The Operating Partnership believes that the structure of these programs causes its managers to exercise their operational autonomy in a manner to maximize income through increased rental rates.
Environmental and Other Regulations
The Operating Partnership is subject to federal, state, and local environmental regulations that apply generally to the ownership of real property and the operation of self-storage facilities. The Operating Partnership has not received notice from any governmental authority or private party of any material environmental noncompliance, claim, or liability in connection with any of the Properties, and is not aware of any environmental condition with respect to any of the Properties that could have a material adverse effect on the Operating Partnership's financial condition or results of operations.
The Properties are also generally subject to the same types of local regulations governing other real property, including zoning ordinances. The Operating Partnership believes that the Properties are in substantial compliance with all such regulations.
Insurance
Each of the Properties is covered by fire, flood and property insurance, including comprehensive liability, all-risk property insurance, provided by reputable companies and with commercially reasonable terms. In addition, the Operating Partnership maintains a policy insuring against environmental liabilities resulting from tenant storage on terms customary for the industry, and title insurance insuring fee title to the Properties in an aggregate amount believed to be adequate.
Competition
The primary factors upon which competition in the self- storage industry is based are location, rental rates, suitability of a property's design to prospective tenants' needs, and the manner in which the property is operated and marketed. The Operating Partnership believes it competes successfully on these bases. The extent of competition depends in significant part on local market conditions. The Operating Partnership seeks to locate its facilities so as not to cause its own Properties to compete with one another for customers, but the number of self- storage facilities in a particular area could have a material adverse effect on the performance of any of the Properties.
Several of the Operating Partnership's competitors, including Public Storage Management, Inc., Shurgard Incorporated, U-Haul International, Storage Trust Realty and Storage USA, Inc., are larger and have substantially greater financial resources than the Operating Partnership. These larger operators may, among other possible advantages, be capable of greater leverage and the payment of higher prices for acquisitions.
Investment Policy
While the Operating Partnership emphasizes equity real estate investments, it may, in its discretion, invest in mortgages and other real estate interests related to self-storage properties consistent with the Company's qualification as a REIT. The Operating Partnership may also retain a purchase money mortgage for a portion of the sale price in connection with the disposition of properties from time to time. Should investment opportunities become available, the Operating Partnership may look to acquire self-storage properties via a joint-venture partnership or similar entity. The Operating Partnership may or may not have a significant investment in such a venture, but would use such an opportunity to expand its portfolio of branded and managed properties.
Subject to the percentage of ownership limitations and gross income tests necessary for the Company's REIT qualification, the Operating Partnership also may invest in securities of entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities.
Disposition Policy
Management periodically reviews the assets comprising the Operating Partnership's portfolio. The Operating Partnership has no current intention to dispose of any of the Properties, although it reserves the right to do so. Any disposition decision will be based on a variety of factors, including, but not limited to, the (i) potential to continue to increase cash flow and value, (ii) sale price, (iii) strategic fit with the rest of the Operating Partnership's portfolio, (iv) potential for, or existence of, environmental or regulatory issues, (v) alternative uses of capital, and (vi) maintaining the Company's qualification as a REIT.
Borrowing Policy
The Board of Directors of the Company currently limits the amount of debt that may be incurred by the Company to less than 50% of the sum of market value of the issued and outstanding Common Stock plus the Company's debt (Market Capitalization). The Company, however, may from time to time re-evaluate and modify its borrowing policy in light of then current economic conditions, relative costs of debt and equity capital, market values of properties, growth and acquisition opportunities and other factors.
The Operating Partnership obtained an increase in the amount available under the Credit Facility to $150 million from $75 million in 1998. In connection with the increase, the interest rate was reduced from LIBOR plus 1.9 % to LIBOR plus 1.25% and the maturity date was extended from August 1998 to February 2001. The Credit Line is to be used for development, acquisitions and general corporate purposes. As a result of the new credit facility, in 1998 the Operating Partnership recorded an extraordinary loss on the extinguishment of debt of $357,000, representing the unamortized financing costs of the revolving credit facility.
On December 22, 1998, the Operating Partnership borrowed $75 million pursuant to a term note agreement. The note is for a period of two years, maturing on December 22, 2000, and requires interest at LIBOR plus 1.50%. The note is unsecured, and was used to repay short-term borrowings.
To the extent that the Operating Partnership desires to obtain additional capital to pay distributions, to provide working capital, to pay existing indebtedness or to finance acquisitions, expansions or development of new properties, the Company may utilize public and private equity offerings, floating or fixed rate debt financing, retention of cash flow (subject to satisfying the Operating Partnership's distribution requirements under the REIT rules) or a combination of these methods. Additional debt financing may also be obtained through mortgages on its Properties, which may be recourse, non-recourse, or cross- collateralized and may contain cross-default provisions. The Operating Partnership has not established any limit on the number or amount of mortgages that may be placed on any single Property or on its portfolio as a whole. For additional information regarding borrowings, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and Note 5 to the Operating Partnership's Financial Statements appearing elsewhere herein.
Employees
The Operating Partnership currently employs a total of 579 employees, including 229 Property Managers, 13 Area Managers, 4 Regional Vice Presidents and 292 part time employees. At the Operating Partnership's headquarters, in addition to the Company's 3 senior executive officers, the Operating Partnership employs 38 people engaged in various support activities such as accounting and management information systems. None of the Operating Partnership's employees is covered by a collective bargaining agreement. The Operating Partnership considers its employee relations to be excellent.
ITEM 2.
ITEM 2. PROPERTIES
Overview
At December 31, 1998, the Operating Partnership, owned 100% fee simple interests in, and operated, a total of 205 Properties, consisting of approximately 11.6 million net rentable square feet, situated in nineteen states in the Eastern and Midwestern United States and Texas. As of December 31, 1998, the Properties had a weighted average occupancy of 86.4% and a weighted average annual rent per square foot of $7.69. The Operating Partnership believes that it is the 5th largest operator of self-storage properties in the United States based on facilities owned.
The Operating Partnership's self-storage facilities offer inexpensive, easily accessible, enclosed storage space to residential and commercial users on a month-to-month basis. Most of the Operating Partnership's Properties are fenced with computerized gates and are well lighted. All but twenty-two of the Properties are single-story, thereby providing customers with the convenience of direct vehicle access to their storage units. All Properties have a Property Manager on-site during business hours. Customers have access to their storage areas during business hours, and some commercial customers are provided 24- hour access. Individual storage units are secured by a lock furnished by the customer to provide the customer with control of access to the unit.
Currently, 189 of the Properties conduct business under the user-friendly trade name "Uncle BoB's Self-Storage" and the remainder are operated under various names acquired with the Properties. The Operating Partnership intends to convert all of the Properties to the "Uncle BoB's" trade name.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
A former business associate (Plaintiff) of certain officers and directors of the Company, including Robert J. Attea, Kenneth F. Myszka, David L. Rogers and Charles E. Lannon, filed a lawsuit against the Company on June 13, 1995 in the United States District Court for the Northern District of Ohio. The Plaintiff has since amended the complaint in the lawsuit alleging breach of fiduciary duty, breach of contract, breach of general partnership/joint venture arrangement, breach of duty of good faith, fraud and deceit, and other causes of action including declaratory judgement as to the Plaintiff's continuing interest in the Company. The Plaintiff is seeking money damages in excess of $15 million, as well as punitive damages and declaratory and injunctive relief (including the imposition of a constructive trust on assets of the Company in which the Plaintiff claims to have a continuing interest) and an accounting. The amended complaint also added Messrs. Attea, Myszka, Rogers and Lannon as additional defendants. The parties are currently involved in discovery. The Company intends to vigorously defend the lawsuit. Messrs. Attea, Myszka, Rogers and Lannon have agreed to indemnify the Company for costs and any loss arising from the lawsuit. The Operating Partnership believes that the actual amount of the Plaintiff's recovery in this matter if any, would be within the ability of these individuals to provide indemnification. The Operating Partnership does not believe that the lawsuit will have a material, adverse effect upon the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the Units. As of March 25, 1999, there were 18 holders of record of Units.
The following table sets forth the quarterly distributions per Unit paid by the Operating Partnership to holders of its Units with respect to each such period.
Quarter Ended Distributions Per Unit
March 31, 1996 .505 June 30, 1996 .505 September 30, 1996 .520 December 31, 1996 .520 March 31, 1997 .520 June 30, 1997 .520 September 30, 1997 .540
December 31, 1997 .540 March 31, 1998 .540 June 30, 1998 .540 September 30, 1998 .560 December 31, 1998 .560
The partnership agreement of the Operating Partnership (the "Partnership Agreement") provides that the Operating Partnership will distribute all available cash (as defined in the Partnership Agreement) on at least a quarterly basis, in amounts determined by the general partner in its sole discretion, to the partners in accordance with their respective percentage interest in the Operating Partnership. Distributions are declared at the discretion of the Board of Directors of Holdings, the general partner of the Operating Partnership and a wholly-owned subsidiary of the Company, and will depend on actual funds from operations of the Operating Partnership, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, and such other factors as the Board of Directors may deem relevant. The Board of Directors of Holdings may modify the Operating Partnership's distribution policy from time to time, subject to the terms of the Partnership Agreement.
The Operating Partnership's line of credit contains customary representations, covenants and events of default, including covenants which restrict the ability of the Operating Partnership to make distributions in excess of stated amounts. In general, during any four consecutive fiscal quarters the Operating Partnership may only distribute up to 90% of the Operating Partnership's funds from operations (as defined in the related agreement). The line of credit contains exceptions to these limitations to allow the Operating Partnership to make any distributions necessary to allow the Company to maintain its status as a REIT. The Operating Partnership does not anticipate that this provision will adversely effect the ability of the Operating Partnership to make distributions, as currently anticipated.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and analysis of the financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included elsewhere in this report.
When used in this discussion and elsewhere in this document, the words "intends," "believes," "anticipates," and similar expressions are intended to identify "forward-looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933 and in Section 21E of Securities Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the Operating Partnership to be materially different from those expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the effect of competition from new self- storage facilities, which would cause rents and occupancy rates to decline; the Operating Partnership's ability to evaluate, finance and integrate acquired businesses into its existing business and operations; the Operating Partnership's ability to effectively compete in the industries in which it does business; the Operating Partnership's cash flow may be insufficient to meet required payments of principal and interest; and tax law changes which may change the taxability of future income.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 compared to Year Ended December 31,
In 1998, the Operating Partnership recorded rental revenues of $68.2 million, an increase of $19.6 million or 40% when compared to 1997 rental revenues of $48.6 million. Of this, $18.4 million resulted from the acquisition of fifty stores during 1998 and from having the 1997 acquisitions included for a full year of operations. The additional $1.2 million increase resulted from increased revenues at the 111 core properties considered in same store sales. For this core group, revenues increased 3.8%, primarily as the result of rental rate increases which were slightly offset by an average occupancy decrease of 1% to 86.4%. Interest and other income increased to $1.1 million in 1998 from $.8 million in 1997.
Property operating and real estate tax expense increased $5.8 million or 42% during the period. Of this, $5.5 million was incurred by the facilities acquired in 1998 and from having the 1997 acquisitions included for a full year of operations, and $0.3 million additional cost was incurred in the operation of the 111 core properties.
General and administrative expenses increased $2.1 million in 1998. Of the increase, $.5 million related to the costs associated with the unsuccessful public debt offering costs in
1998. The additional increase was primarily a result of increased supervisory and accounting costs associated with the operation of an increased number of properties, and the change in the treatment of internal property acquisition costs as discussed in Note 14 to the financial statements.
In 1998, interest expense increased to $9.6 million from $2.2 million as a result of increased borrowings under the line of credit and term note. The credit facility and term note were utilized throughout 1998 to fund the purchase of the fifty stores, as opposed to 1997 in which the Operating Partnership issued additional Units to fund a portion of the acquired stores.
Depreciation and amortization expense increased to $10.3 million from $7.0 million, primarily as a result of the additional depreciation taken on the $170 million of real estate assets acquired in 1998 and a full year of depreciation on 1997 acquisitions.
Earnings before interest, depreciation and amortization, and extraordinary loss increased 36.8% from $32.9 million in 1997 to $45.1 million in 1998 as a result of the aforementioned items.
A $.36 million extraordinary loss was recorded in 1998 when the Operating Partnership's former unsecured credit facility was replaced with a new line of credit with more favorable terms.
Year Ended December 31, 1997 compared to Year Ended December 31,
Rental revenues improved from $32.9 million for the year ended December 31, 1996 to $48.6 million for the year ended December 31, 1997, an increase of $15.7 million, or 48%. Of this, $10.4 million resulted from the acquisition of forty-four properties during 1997, $4.3 million resulted from having the 1996 acquisitions included for a full year of operations, and $1 million resulted from increased revenues at the eighty-two core properties considered in same store sales. For this core group, revenues increased 3.8%, primarily as the result of rental rate increases, as average occupancy was unchanged from 1996's level of 87.8%. Interest and other income increased slightly to $0.8 million in 1997.
Property operating and real estate tax expense increased $4.5 million or 49% during the period. Of this, $3.1 million was incurred by the facilities acquired in 1997, $1.3 million resulted from the having the 1996 acquisitions included for a full year of operations, and $0.1 million additional cost was incurred in the operation of the eighty-two core properties.
General and administrative expenses increased $0.5 million, primarily as a result of increased supervisory and accounting costs associated with the operation of an increased number of properties.
Interest expense of $2.2 million in 1997 resulted primarily from borrowings on the Operating Partnership's line of credit facility (a mortgage loan assumed in an acquisition transaction required interest payments of $0.2 million). The Operating Partnership had borrowings outstanding of $42 million before paying off the balance with the proceeds of the Company's common stock offering in April 1997. The credit facility was then utilized throughout the balance of the year to fund further acquisitions, so that by the end of the year, the amount outstanding on the line was $36 million.
Depreciation and amortization expense increased to $7 million from $4.6 million, primarily as a result of the additional depreciation taken on the $112 million of real estate assets acquired in 1997 and a full year of depreciation on 1996 acquisitions.
Earnings before interest, depreciation and amortization increased $10.7 million or 48%, in 1997 as a result of the aforementioned items.
Pro Forma Year Ended December 31, 1998 compared to Pro Forma Year Ended December 31, 1997
The following unaudited pro forma information shows the results of operations as though the acquisitions of storage facilities in 1998 and 1997, and the Company's common stock offerings in 1997 had all occurred as of the beginning of 1997.
Year Ended December 31, (Dollars in thousands) 1998 1997 _________________________________________________________________ Revenues: Rental income $75,683 $72,557 Interest and other income 1,269 1,142 _________________________________________________________________ Total revenues 76,952 73,699 _________________________________________________________________ Expenses: Property operations and maintenance 15,576 15,019 Real estate taxes 6,333 5,972 General and administrative 4,900 3,900 Interest 12,976 12,976 Depreciation and amortization 11,509 11,509 _________________________________________________________________ Total expenses 51,294 49,376 _________________________________________________________________ Income before extraordinary item $ 25,658 $ 24,323 Extraordinary loss on extinguishment of debt (357) - _________________________________________________________________ Net income $ 25,301 $ 24,323 _________________________________________________________________
Rental revenue of $76.9 million in 1998 increased by 4.4% over 1997's revenues of $73.7 million, primarily as a result of rate increases at the stores.
Operating expenses and real estate taxes in 1998 were $21.9 million, as compared to $20.9 million in 1997, an increase of 4.4%. While cost efficiencies were enjoyed regarding insurance and yellow-page advertising, these savings were offset by the Operating Partnership's paying higher wages to attract professional managers, and increased property taxes.
General and administrative costs were determined by the Operating Partnership's historical costs incurred in the management of 205 properties.
Interest expense in both years was determined by applying the year-end rate and the applicable non-usage fee associated with the Operating Partnership's $150 million credit facility and $75 million term note.
Such unaudited pro forma information is based upon the historical statements of operations of the Operating Partnership. It should be read in conjunction with the financial statements of the Operating Partnership and notes thereto. In management's opinion, all adjustments necessary to reflect the effects of these transactions have been made. This unaudited pro forma statement does not purport to represent what the actual results of operations of the Operating Partnership would have been assuming such transactions had been completed as set forth above, nor does it purport to represent the results of operations for future periods.
LIQUIDITY AND CAPITAL RESOURCES Capital Resources, Unsecured Line of Credit and Term Note
Prior to 1998, the Operating Partnership relied principally on equity capital, using the proceeds of the offerings to repay indebtedness, to purchase additional properties, and to acquire limited partners' interests in the Sovran Partnerships.
The equity offerings have been supplemented with borrowings on the Operating Partnership's line of credit which was replaced on February 20, 1998, by a three-year, $150 million unsecured line. The commitment fee on the new line was $750,000, and interest is payable monthly at 125 basis points above LIBOR. The use of the unsecured line of credit has allowed 99% of the Operating Partnership's portfolio to be unsecured as of December 31, 1998. The available balance on the unsecured credit line at December 31, 1998 was $38 million.
In 1998, the Operating Partnership secured investment grade ratings from Standard and Poors (BBB-), Moodys (Baa3), and Duff and Phelps (BBB-). This provided for reduced borrowing costs (12.5 basis points) under the unsecured line of credit instrument.
In 1998, the Operating Partnership attempted to enter the public debt markets with the issuance of senior notes. The note offerings were not executed as management determined market conditions required payment of unfavorable interest rates. The Operating Partnership opted instead to enter a $75 million two- year unsecured term note with a syndicate of banks at an interest rate of LIBOR plus 1.50%. The proceeds were used to repay a short-term note and to pay down a portion of the unsecured line of credit.
In addition to the equity and debt capital, the Operating Partnership issued $11.4 million and $9.2 million of Operating Partnership Units in 1998 and 1997, respectively, in exchange for self-storage facilities.
In 1998, the Company repurchased $2 million of Common Stock as part of a program authorized by the Board of Directors.
Acquisition of Properties
During 1998 the Operating Partnership used borrowings pursuant to the line of credit and term note and the issuance of Operating Partnership Units to acquire 50 properties comprising 3.2 million square feet from unaffiliated storage operators. These properties are located in existing markets in Alabama, Florida, Georgia, Massachusetts, Michigan, Mississippi, New York, North Carolina, Ohio, Rhode Island, Texas, and Virginia. The Operating Partnership also entered two new states, New Hampshire and Tennessee during 1998. In 1997, forty-four facilities totaling 2.5 million square feet were acquired. At December 31,1998, a total of 205 facilities and 11.6 million square feet of net rentable storage space was owned and operated by the Operating Partnership in 19 states.
Internal Property Acquisition Costs
As a result of a recent consensus reached by the Financial Accounting Standards Board Emerging Issues Task Force, the Operating Partnership no longer capitalizes internal costs related to the acquisition of operating properties. The amount of such costs capitalized in 1998 (through the effective date of the pronouncement) and 1997 was $238,000 and $728,000, respectively.
Future Acquisition and Development Plans
The Operating Partnership's external growth strategy is to increase the number of facilities it owns by acquiring suitable facilities in markets in which it already has operations, or to expand in new markets by acquiring several facilities at once in those new markets.
At December 31, 1998, the Operating Partnership had contracts totaling of $15.3 million to acquire additional properties in Providence, RI and Lafayette, LA.
The Operating Partnership will continue to aggressively pursue the acquisition of quality self-storage properties in markets where it already operates, and in strategic new markets where a substantial property base can be quickly established.
The Operating Partnership also intends to expand and enhance certain of its existing facilities by building additional storage buildings on presently vacant land and by installing climate control and enhanced security systems at selected sites.
Distribution Requirements of the Company and Impact on the Operating Partnership
As a REIT, the Company is not required to pay federal income tax on income that it distributes to its shareholders, provided that the amount distributed is equal to at least 95% of taxable income. These distributions must be made in the year to which they relate, or in the following year if declared before the Company files its federal income tax return, and if it is paid before the first regular dividend of the following year. The first distribution of 1999 may be applied toward the Company's 1998 distribution requirement. The Company's source of funds for such distributions are solely and directly from the Operating Partnership.
As a REIT, the Company must derive at least 95% of its total gross income from income related to real property, interest and dividends. In 1998, the Company's percentage of revenue from such sources exceeded 97%, thereby passing the 95% test, and no special measures are expected to be required to enable the Company to maintain its REIT designation.
INTEREST RATE RISK
The Operating Partnership entered into interest rate swap agreements to manage its exposure to interest rate changes. The swaps involve the exchange of fixed and variable interest rate payments without exchanging the notional principal amount. Payments or receipts on the agreements are recorded monthly as adjustments to interest expense. At December 31, 1998, the Operating Partnership had interest rate swaps with notional amounts of $40 million through June 1999 and $55 million through December 1999. Under these agreements the Operating Partnership receives a floating interest rate based upon LIBOR and pays a fixed interest rate of 5.78% on the $40 million amount and 5.12% on the $55 million amount.
Based upon the Operating Partnership's indebtedness at December 31, 1998, and taking the interest rate swap agreements into account, a 1% increase in interest rates would result in an increase to interest expense of approximately $1.3 million.
INFLATION
The Operating Partnership does not believe that inflation has had or will have a direct effect on its operations.
Substantially all of the leases at the facilities allow for monthly rent increases, which provide the Operating Partnership with the opportunity to achieve increases in rental income as each lease matures.
SEASONALITY
The Operating Partnership's revenues typically have been higher in the third and fourth quarter, primarily because the Operating Partnership increases its rental rates on most of its storage units at the beginning of May and, to a lesser extent, because self-storage facilities tend to experience greater occupancy during the late spring, summer and early fall months due to the greater incidence of residential moves during these periods. However, the Operating Partnership believes that its tenant mix, diverse geographic locations, rental structure and expense structure provide adequate protection against undue fluctuations in cash flows and net revenues during off-peak seasons. Thus, the Operating Partnership does not expect seasonality to affect materially distributions to unitholders.
IMPACT OF YEAR 2000
The Operating Partnership employs several different computer systems for financial reporting, property management, asset control and payroll. These systems are purchased by the Operating Partnership from third parties and therefore there is no internally generated programming code. The Operating Partnership has been assessing and testing its systems to determine if its hardware and software will function properly with respect to dates in the Year 2000 and thereafter, and no significant problems were noted. The Operating Partnership's critical applications relating to financial reporting, property management and asset control have been updated to Year 2000 compliant versions within the last year as part of the normal maintenance agreements.
The Operating Partnership communicates electronically with certain outside vendors in the banking and payroll processing areas. The Operating Partnership has been advised by these vendors that their systems are or will be Year 2000 compliant. The Operating Partnership has identified and evaluated certain other systems that may be impacted by the Year 2000, such as gates, security systems and elevators. The Operating Partnership expects the implementation of any required solutions to be completed by December 31, 1999, and the cost to be less than $50,000. The Operating Partnership is not aware of any other vendors or suppliers for which the Year 2000 would materially impact the Operating Partnership's business. The Operating Partnership has no means of ensuring that outside companies will be Year 2000 compliant, and there can be no assurance that the Operating Partnership has identified all such companies.
The Operating Partnership will continue to address the Year 2000 throughout 1999 and has developed a contingency plan if the implementations are not completed timely. Under a worst case scenario, the Operating Partnership will have the ability to revert to a manual system to operate its self-storage stores if any issues with the Year 2000 are encountered. Despite the approach being taken to prevent a Year 2000 problem, the operating Partnership cannot be completely sure that issues will not arise, or events will not occur that could have material adverse affects on the Operating Partnership's results of operations or financial condition.
Year 2000 costs and the date on which the Operating Partnership believes that it will be Year 2000 compliant are based upon management's best estimates that were derived utilizing numerous assumptions of future events. There can be no assurance that these estimates are achievable and actual results could differ materially from estimates.
UNITHOLDER INFORMATION
CORPORATE HEADQUARTERS 5166 Main Street Williamsville, New York 14221 716-633-1850
SOVRAN'S WEBSITE http://www.sovranss.com http://www.unclebobsselfstorage.com
FORM 10-K REPORT A copy of the Operating Partnership's Annual Report on Form 10-K for the year ended December 31, 1998, filed with the Securities Exchange Commission, will be furnished to unitholders without charge upon written request. Please contact Christine M. Aguglia, 716-633-1850
INVESTOR RELATIONS For more information or to receive Sovran's quarterly reports, please contact Joan M. Light, 716-633-1850
INDEPENDENT AUDITORS Ernst & Young LLP 1400 Key Tower Buffalo, New York 14202
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required is included in Item 7 under the heading Interest Rate Risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Balance Sheets - Sovran Acquisition Limited Partnership
December 31, (Dollars in thousands) 1998 1997 ____ ____ Assets Investment in storage facilities: Land $102,864 $ 71,391 Building and equipment 399,638 261,645 _______ _______ 502,502 333,036 Less accumulated depreciation (21,339) (11,639) _______ _______ Investments in storage facilities, net 481,163 321,397 Cash and cash equivalents 2,984 2,567 Accounts receivable 1,699 834 Prepaid expenses and other assets 4,278 2,275 _______ _______ Total Assets $490,124 $327,073 ======== ========
Liabilities Line of credit $112,000 $ 36,000 Term note 75,000 - Accounts payable and accrued liabilities 3,059 1,950 Deferred revenue 2,943 1,994 Accrued distributions 7,378 6,816 Mortgage payable 3,059 3,559 _______ _______ Total Liabilities 203,439 50,319
Limited partners' capital interest (863,037 and 443,609 units, respectively), at redemption value (Note 1) 21,683 14,454
Partners' Capital General partner (219,567 and units issued and outstanding, in 1998 and 1997) 5,284 5,257 Limited partner (12,093,439 and 12,001,554 units issued and outstanding, respectively) 259,718 257,043 _______ _______ Total partners' capital 265,002 262,300 _______ _______ Total liabilities and partners' capital $490,124 327,073 ======== ========
(See notes to financial statements.)
Sovran Acquisition Limited Partnership
Statements of Operations
Operating Partnership __________________________________________ Year Ended Year Ended Year Ended Dollars in thousands, December 31, December 31, December 31, except per unit data) 1998 1997 1996 __________________________________________ Revenues: Rental income $68,231 $48,584 $32,946 Interest and other income 1,129 770 651 _______ _______ _______ Total revenues 69,360 49,354 33,597
Expenses: Property operations and maintenance 13,793 9,708 6,662 Real estate taxes 5,659 3,955 2,464 General and administrative 4,849 2,757 2,282 Interest 9,601 2,166 1,924 Depreciation and amortization 10,303 7,005 4,583 _______ _______ _______ Total expenses 44,205 25,591 17,915 _______ _______ _______ Income before extraordinary item 25,155 23,763 15,682 Extaordinary loss on extinguishment of debt (357) - - _______ _______ _______
Net income $24,798 $23,763 $15,682 ======= ======= ======= Earnings per unit before extraordinary item-basic $ 1.94 $ 1.97 $ 1.88
Extraordinary loss $ (0.03) $ - $ -
Earnings per unit-basic $ 1.91 $ 1.97 $ 1.88
Earnings per unit-diluted $ 1.91 $ 1.96 $ 1.87
Distributions declared per unit $ 2.20 $ 2.12 $ 2.05
(See notes to financial statements.)
NOTES TO FINANCIAL STATEMENTS Sovran Acquisition Limited Partnership - December 31, 1998
1. ORGANIZATION
Sovran Acquisition Limited Partnership (the "Operating Partnership") is the entity through which Sovran Self Storage, Inc. (the "Company"), a self-administered and self-managed real estate investment trust ("REIT"), conducts substantially all of its business and owns substantially all of its assets. In 1995, the Company was formed under Maryland law and the Operating Partnership was organized as a Delaware limited partnership to continue and to expand the self-storage operations of the Company's privately owned predecessor organizations. On June 26, 1995, the Company commenced operations, through the Operating Partnership, effective with the completion of its initial public offering of 5,890,000 shares. Since its formation the Operating Partnership has purchased a total of 131 (fifty in 1998, forty- four in 1997, twenty-nine in 1996 and eight in 1995) self storage properties from unaffiliated third parties, increasing the total number of self-storage properties owned at December 31, 1998 to 205 properties, most of which are in the eastern United States and Texas.
As of December 31, 1998, the Company was a 93.45% economic owner of the Operating Partnership and controls it through Sovran Holdings, Inc. ("Holdings"), a wholly owned subsidiary of the Company incorporated in Delaware and the sole general partner of the Operating Partnership (this structure is commonly referred to as an umbrella partnership REIT or "UPREIT"). The board of directors of Holdings, the members of which are also members of the Board of Directors of the Company, manages the affairs of the Operating Partnership by directing the affairs of Holdings. The Company's limited partner and indirect general partner interests in the Operating Partnership entitle it to share in cash distributions from, and in the profits and losses of, the Operating Partnership in proportion to its ownership interest therein and entitle the Company to vote on all matters requiring a vote of the limited partners.
The other limited partners of the Operating Partnership are persons who contributed their direct or indirect interests in certain self-storage properties to the Operating Partnership. The Operating Partnership is obligated to redeem each unit of limited partnership ("Unit") at the request of the holder thereof for cash equal to the fair market value of a share of the Company's common stock ("Common Shares") at the time of such redemption, provided that the Company at its option may elect to acquire any Unit presented for redemption for one Common Share or cash. The Company presently anticipates that it will elect to issue Common Shares to acquire Units presented for redemption, rather than paying cash. With each such redemption the Company's percentage ownership interest in the Operating Partnership will increase. In addition, whenever the Company issues Common Shares, the Company is obligated to contribute any net proceeds therefrom to the Operating Partnership and the Operating
Partnership is obligated to issue an equivalent number of Units to the Company. Such limited partners' redemption rights are reflected in "limited partners' capital interest" in the accompanying balance sheets at the cash redemption amount at the balance sheet date. Capital activity with regard to such limited partners' redemption rights is reflected in the accompanying statements of partners' capital.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents: The Operating Partnership considers all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents.
Revenue Recognition: Rental income is recorded when earned. Rental income received prior to the start of the rental period is included in deferred revenue.
Interest and Other Income: Other income consists primarily of interest income, sales of storage-related merchandise (locks and packing supplies) and commissions from truck rentals.
Investment in Storage Facilities: Storage facilities are recorded at cost. Depreciation is computed using the straight line method over estimated useful lives of forty years for buildings and improvements, and five to twenty years for furniture, fixtures and equipment. Expenditures for significant renovations or improvements which extend the useful life of assets are capitalized. Repair and maintenance costs are expensed as incurred.
Whenever events or changes in circumstances indicate that the basis of the Operating Partnership's property may not be recoverable, the Operating Partnership's policy is to assess any impairment of value. Impairment is evaluated based upon comparing the sum of the expected undiscounted future cash flows to the carrying value of the property; on a property by property basis. If the sum of the cash flow is less than the carrying amount, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. At December 31, 1998 and 1997, no assets had been determined to be impaired under this policy, and, accordingly, this policy had no impact on the Operating Partnership's financial position or results of operations.
Prepaid Expenses and Other Assets: Included in prepaid expenses and other assets are prepaid expenses and intangible assets. The intangible assets at December 31, 1998, consist primarily of loan acquisition costs of approximately $1,824, net of accumulated amortization of approximately $244; organizational costs of approximately $63, net of accumulated amortization of approximately $42; and covenants not to compete of $785, net of accumulated amortization of $555. Loan acquisition costs are amortized over the terms of the related debt; organization costs are amortized over five years; and the covenants are amortized
over the contract periods. Amortization expense was $541, $794 and $620 for the periods ended December 31, 1998, 1997 and 1996, respectively.
Income Taxes: No provision has been made for income taxes in the accompanying financial statements since the Operating Partnership qualifies as a partnership for federal and state income tax purposes and its partners are required to include their respective shares of profits and losses in their income tax returns.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
3. EARNINGS PER UNIT
The Operating Partnership reports earnings per unit data in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share." The following table sets forth the computation of basic and diluted earnings per unit.
Year Ended Year Ended Year Ended (Dollars in thousands, December 31, December 31, December 31, except per unit data) 1998 1997 1996 ___________________________________________________________________ Numerator: Net Income $ 24,798 $ 23,763 $ 15,682 ___________________________________________________________________ Denominator: Denominator for basic earnings per unit - weighted average units 12,948 12,090 8,344 ___________________________________________________________________ Effect of Dilutive Securities: Options for Company stock 38 62 35 Denominator for diluted earnings per unit - adjusted weighted - average units and assumed conversion 12,986 12,152 8,379 __________________________________________________________________ Basic Earnings per Unit $ 1.91 $ 1.97 $ 1.88
Diluted Earnings per Unit $ 1.91 $ 1.96 $ 1.87 __________________________________________________________________
4. INVESTMENT IN STORAGE FACILITIES
The following summarizes activity in storage facilities during the years ended December 31, 1998 and December 31, 1997
(Dollars in Thousands) 1998 1997 ________________________________________________________________
Cost: Beginning balance $ 333,036 $ 220,711 Property acquisitions 157,080 106,926 Improvements and equipment additions 12,940 5,527 Dispositions (554) (128) ________________________________________________________________ Ending balance $ 502,502 $ 333,036 ________________________________________________________________
Accumulated Depreciation: Beginning balance $ 11,639 $ 5,457 Additions during the year 9,762 6,211 Dispositions (62) (29) ________________________________________________________________ Ending balance $ 21,339 $ 11,639 ________________________________________________________________
5. UNSECURED LINE OF CREDIT AND TERM NOTE
In February 1998, the Operating Partnership entered into a new $150 million unsecured credit facility which replaced in its entirety the Operating Partnership's $75 million revolving credit facility. The new facility matures February 2001 and provides for funds at LIBOR plus 1.25%, a savings of 65 basis points over the Operating Partnership's old facility. The average interest rate at December 31, 1998 on the line of credit was approximately 6.6%. At December 31, 1998, there was $38 million available on the line. As a result of the new credit facility, in 1998 the Operating Partnership recorded an extraordinary loss on the extinguishment of debt of $357,000 representing the unamortized financing costs of the former revolving credit facility and related costs.
In December 1998, the Operating Partnership entered into a $75 million unsecured term note that matures on December 22, 2000 and bears interest at LIBOR plus 1.50% (approximately 6.8% at December 31, 1998).
The Operating Partnership entered into interest rate swap agreements to manage its exposure to interest rate changes. The swaps involve the exchange of fixed and variable interest rate payments without exchanging the notional principal amount. Payments or receipts on the agreements are recorded monthly as adjustments to interest expense. At December 31, 1998, the Operating Partnership had interest rate swaps with notional amounts of $40 million through June 1999 and $55 million through December 1999. Under these agreements the Operating Partnership receives a floating interest rate based upon LIBOR and pays a
fixed interest rate of 5.78% on the $40 million amount and 5.12% on the $55 million amount. The net carrying amount of the Operating Partnership's debt instruments approximates fair value.
6. PRO FORMA FINANCIAL INFORMATION (UNAUDITED)
The following unaudited pro forma information shows the results of operations as though the acquisitions of storage facilities in 1998 and 1997, and the common stock offerings of the Company in 1997 had all occurred as of the beginning of 1997.
(Dollars in thousands, except Year ended December 31, unit data) 1998 1997 _________________________________________________________________ Total revenues $ 76,952 $ 73,699 _________________________________________________________________ Total expenses (51,294) (49,376) _________________________________________________________________ Income before extraordinary loss $ 25,658 $ 24,323 _________________________________________________________________ Net Income $ 25,301 $ 24,323 _________________________________________________________________ Earnings per unit before extraordinary loss - basic $ 1.95 $ 1.85 _________________________________________________________________ Earnings per unit - basic $ 1.92 $ 1.85 _________________________________________________________________ Earnings per unit - diluted $ 1.92 $ 1.85 _________________________________________________________________ Units used in basic earnings per unit calculation 13,175,793 13,175,793 _________________________________________________________________
Such unaudited pro forma information is based upon the historical statements of operations of the Operating Partnership. It should be read in conjunction with the financial statements of the Operating Partnership and notes thereto. In management's opinion, all adjustments necessary to reflect the effects of these transactions have been made. This unaudited pro forma statement does not purport to represent what the actual results of operations of the Operating Partnership would have been assuming such transactions had been completed as set forth above, nor does it purport to represent the results of operations for future periods.
7. STOCK OPTIONS
The Operating Partnership continues to account for Company stock-based compensation using the measurement prescribed by APB Opinion No. 25 which does not recognize compensation expense because the exercise price of the stock options equals the market price of the underlying stock on the date of grant. Statement of
Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation," requires companies that choose not to adopt the new fair value accounting rules to disclose pro forma net income and earnings per unit under the new method. The Operating Partnership will issue a Unit to the Company for each common share of the Company issued under the following plans.
The Company has established the 1995 Award and Option Plan (the Plan) for the purpose of attracting and retaining the Company's executive officers and other employees. The options vest ratably over four and five years, and must be exercised within ten years from the date of grant. The exercise price for qualified incentive stock options must be at least equal to the fair market value at the date of grant. As of December 31, 1998, options for 350,100 shares were outstanding under the Plan. The total options available under the Plan (including restricted stock issuances is 400,000.
The Company also established the 1995 Outside Directors' Stock Option Plan (the Non-employee Plan) for the purpose of attracting and retaining the services of experienced and knowledgeable outside directors. The Non-employee Plan provides for the annual granting of options to purchase 2,500 shares of common stock to each eligible director. Such options vest over a one-year period for initial awards and immediately upon subsequent grants. The total shares reserved under the Non- employee Plan is 50,000. The exercise price for options granted under the Non-employee Plan is equal to fair market value at date of grant. As of December 31, 1998, options for 37,500 shares were outstanding under the Non-employee Plan.
The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 5.5% for 1998 and 6% for 1997, dividend yield of 8% for 1998 and 7% for 1997, volatility factor of the expected market price of the Company's common stock of .19 for 1998 and .16 for 1997.
The Black-Scholes options valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Operating Partnership's pro forma information for the year ended December 31, 1998 and 1997 follows (in thousands, except for earnings per unit information).
1998 1997 _________________________________________________________________
Pro forma net income $ 24,640 $ 23,620 Pro forma earnings per share: Basic $ 1.90 $ 1.95 Diluted $ 1.90 $ 1.94
The pro forma effect on earnings for the year ended December 31, 1996 was immaterial.
The Company has also issued 17,400 shares of restricted stock to employees which vest over a four and five year periods. The fair value of the restricted stock on the date of grant ranged from $25.88 to $29.19.
8. RETIREMENT PLAN
Employees of the Operating Partnership qualifying under certain age and service requirements are eligible to be a participant in a 401(K) Plan which was effective September 1, 1997. The Operating Partnership contributes to the Plan at the rate of 50% of the first 4% of gross wages. Total expense to the Operating Partnership was approximately $53,000 and $15,000 for the year ended December 31, 1998 and 1997, respectively.
9. SHAREHOLDER RIGHTS PLAN
In November 1996, the Company adopted a Shareholder Rights Plan and declared a dividend distribution of one Right for each outstanding share of common stock. Under certain conditions, each Right may be exercised to purchase one one-thousandth of a share of Series A Junior Participating Preferred Stock at a purchase price of $75, subject to adjustment. The Rights will be exercisable only if a person or group has acquired 10% or more of the outstanding shares of common stock, or following the commencement of a tender or exchange offer for 10% or more of such outstanding shares of common stock. If a person or group acquires more than 10% of the then outstanding shares of common stock, each Right will entitle its holder to receive, upon exercise, common stock having a value equal to two times the exercise price of the Right. In addition, if the Company is acquired in a merger or other business combination transaction, each Right will entitle its holder to purchase that number of the acquiring Company's common shares having a market value of twice the Right's exercise price. The Company will be entitled to redeem the Rights at $.01 per Right at any time prior to the earlier of the expiration of the Rights in November 2006 or the time that a person has acquired a 10% position. The Rights do not have voting or dividend rights, and until they become exercisable, have no dilutive effect on the Operating Partnership's earnings.
10. SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of quarterly results of operations for the years ended December 31, 1998 and 1997(dollars in thousands, except per unit data)
1998 Quarter Ended _________________________________________
March 31 June 30 Sept. 30 Dec. 31 _________________________________________
Revenue $14,375 $16,442 $19,107 $19,436 Income before extraordinary loss $ 6,203 $ 6,271 $ 6,638 $ 6,036 Net Income $ 5,853 $ 6,271 $ 6,638 $ 6,036 Net Income Per Unit (Note 3): Before extraordinary Loss - Basic $ 0.49 $ 0.49 $ 0.50 $ 0.46 Basic $ 0.46 $ 0.49 $ 0.50 $ 0.46 Diluted $ 0.46 $ 0.49 $ 0.50 $ 0.46
1997 Quarter Ended _________________________________________ March 31 June 30 Sept. 30 Dec. 31 _________________________________________ Revenue $10,732 $11,938 $13,320 $13,364 Net Income $ 4,935 $ 6,189 $ 6,559 $ 6,080 Net Income Per Unit (Note 3): Basic $ 0.46 $ 0.50 $ 0.52 $ 0.49 Diluted $ 0.46 $ 0.50 $ 0.52 $ 0.48
11. COMMITMENTS AND CONTINGENCIES
The Operating Partnership's current practice is to conduct environmental investigations in connection with property acquisitions. At this time, the Operating Partnership is not aware of any environmental contamination of any of its facilities which individually or in the aggregate would be material to the Operating Partnership's overall business, financial condition, or results of operations.
As of December 31, 1998, the Operating Partnership had entered into contracts for the purchase of six facilities. These facilities were acquired in January and February, 1999 for a total cost of $15,310,000.
12. LEGAL PROCEEDINGS
A former business associate (Plaintiff) of certain officers and directors of the Company, including Robert J. Attea, Kenneth F. Myszka, David L. Rogers and Charles E. Lannon, filed a lawsuit against the Company on June 13, 1995 in the United States District Court for the Northern District of Ohio. The Plaintiff has since amended the complaint in the lawsuit alleging breach of fiduciary duty, breach of contract, breach of general partnership/joint venture arrangement, breach of duty of good faith, fraud and deceit, and other causes of action including declaratory judgement as to the Plaintiff's continuing interest in the Company. The Plaintiff is seeking money damages in excess of $15 million, as well as punitive damages and declaratory and injunctive relief (including the imposition of a constructive trust on assets of the Company in which the Plaintiff claims to have a continuing interest) and an accounting. The amended complaint also added Messrs. Attea, Myszka, Rogers and Lannon as additional defendants. The parties are currently involved in discovery. The Company intends to vigorously defend the lawsuit. Messrs. Attea,Myszka, Rogers and Lannon have agreed to indemnify the Company for costs and any loss arising from the lawsuit. The Operating Partnership believes that the actual amount of the Plaintiff's recovery in this matter if any, would be within the ability of these individuals to provide indemnification. The Operating Partnership does not believe that the lawsuit will have a material, adverse effect upon the Operating Partnership.
13. INTERNAL PROPERTY ACQUISITION COSTS
On March 19, 1998 the Financial Accounting Standards Board Emerging Issues Task Force reached a consensus as to the accounting for internal acquisition costs incurred in connection with real property. The Task Force consensus indicates that internal costs related to the acquisition of operating properties should be expensed as incurred. The Operating Partnership had previously capitalized such costs and has complied with the consensus prospectively. The amount of such costs capitalized in 1998 (through the date of the pronouncement) and 1997 were $238,000 and $728,000, respectively.
Report of Independent Auditors
The Board of Directors and Partners Sovran Acquisition Limited Partnership:
We have audited the accompanying balance sheets of Sovran Acquisition Limited Partnership as of December 31, 1998 and 1997 and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31,1998. Our audit also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the management of Sovran Acquisition Limited Partnership. Our responsibility is to express an opinion on these financial statements and schedules 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Sovran Acquisition Limited Partnership as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Ernst & Young LLP Buffalo, New York January 29, 1999
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Through Holdings, a wholly-owned subsidiary of the Company and the sole general partner of the Operating Partnership, the Company controls the Operating Partnership. The Board of Directors of Holdings, the members of which are the same as the members of the Board of Directors of the Company, manages the affairs of the Operating Partnership by directing the affairs of the general partner of the Operating Partnership. The Operating Partnership has no directors, or executive officers. Consequently, this information incorporated by reference reflects information with respect to the directors and executive officers of the Company and Holdings.
The information required is incorporated by reference to "Election of Directors", including "Executive Officers of the Company" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for the Annual Meeting of Shareholders of the Company to be held on May 25, 1999.
Item 11.
Item 11. Executive Compensation
Through Holdings, a wholly-owned subsidiary of the Company and the sole general partner of the Operating Partnership, the Company controls the Operating Partnership. The Board of Directors of Holdings, the members of which are the same as the members of the Board of Directors of the Company, manages the affairs of the Operating Partnership by directing the affairs of the general partner of the Operating Partnership. The Directors and Officers of Holdings receive their compensation from the Company and are not separately compensated by Holdings. Consequently, the information incorporated by reference reflects compensation paid to the Directors and executive officers of the Company.
The information required is incorporated by reference to "Executive Compensation" and "Compensation of Directors" in the Company's Proxy Statement for Annual Meeting of Shareholders of the Company to be held May 25, 1999.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The Operating Partnership has no directors or officers. No director or officer of the Company or Holdings beneficially owns any Units.
The Company beneficially owns 12,313,006 Units which constitute 93.45% of all outstanding Units. No other person holds more than a 5% beneficial ownership in the Operating Partnership.
The information required herein for the Company is incorporated by reference to "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement for Annual Meeting of Shareholders of the Company to be held on May 25, 1999.
RECENT SALES OF UNREGISTERED SECURITIES
During the past three years, the Operating Partnership has issued Units in private placements in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended, in the amounts and for the consideration set forth below:
- On January 20, 1996, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Operating Partnership issued 1980 Units to the Company and 20 general partnership units to Holdings.
- On July 25, 1996, Thomas Hinkel and Hinkel Investment Limited Partnership transferred their interest in a self-storage facility to the Operating Partnership in exchange for 6,327.8 and 12,459.37 Units, respectively.
- On October 1, 1996, the Company transferred $65,959,000 to the Operating Partnership in exchange for 2,710,000 Units and Holdings transferred $974,000 to the Operating Partnership in exchange for 40,000 general partnership units.
- On October 8, 1996, the Company transferred $9,940,000 to the Operating Partnership in exchange for 408,375 Units and Holdings transferred $100,000 to the Operating Partnership in exchange for 4,125 general partnership units.
- On December 18, 1996, Harold Samloff and Laurence Glaser transferred their interest in a self-storage facility to the Operating Partnership in exchange for 60,571.425 Units for each of them.
- On February 26, 1997, the Company transferred $34,500 to the Operating Partnership in exchange for 1,500 Units in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan.
- On March 31, 1977, Montague-Betts Company and D.W.B. Associates transferred their interests in certain self- storage properties to the Operating Partnership in exchange for 214,974.46 and 28,953.02 Units, respectively.
- On April 22, 1997, the Company transferred $39,148,000 to the Operating Partnership in exchange for 1,400,000 Units and Holdings transferred $2,796,000 to the Operating Partnership in exchange for 100,000 general partnership units.
- On May 21, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $51,750 to the Operating Partnership in exchange for 2,250 units.
- On June 22, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $34,500 to the Operating Partnership in exchange for 1,500 Units.
- On June 23, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $69,000 to the Operating Partnership in exchange for 3,000 Units.
- On June 24, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $69,000 to the Operating Partnership in exchange for 3,000 Units.
- On June 26, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $69,000 to the Operating Partnership in exchange for 3,000 Units.
- On November 12, 1997, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Operating Partnership issued 200 Units to the Company.
- On December 2, 1997 Frank Bingman, Joseph & Beverly Snyder, Morgan Whiteley and Marlene Whiteley transferred their interest in a self-storage facility to the Operating Partnership in exchange for 19,917.0124, 19,917.0124, 9,958.5062 and 9,958.5062 Units, respectively.
- On February 4, 1998, the Company transferred its interest in a self-storage facility to the Operating Partnership in exchange for 109,841.25 Units.
- On May 12, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Operating Partnership issued 15,450 Units to the Company.
- On June 3, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $51,750 to the Operating Partnership in exchange for 2,250 Units.
- On June 12, 1998 Storage 17, Inc. transferred their interest in a self-storage facility to the Operating Partnership in exchange for 10,000 Units.
- On July 1, 1998 Charles F. Waldner and AWP Limited Partnership transferred their interest in certain self- storage facilities to the Operating Partnership in exchange for 323,454.67 and 85,973.76 Units, respectively.
- On November 4, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $155,250 to the Operating Partnership in exchange for 6,750 Units.
- On November 10, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $92,000 to the Operating Partnership in exchange for 4,000 Units.
- On November 23, 1998, in connection with the Sovran Self Storage, Inc. Dividend Reinvestment and Stock Purchase Plan, the Company transferred $3,300 to the Operating Partnership in exchange for 133 Units.
- On December 4, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $42,550 to the Operating Partnership in exchange for 1,850 Units.
- On December 11, 1998, in connection with the Sovran Self Storage, Inc. 1995 Award and Option Plan, the Company transferred $20,700 to the Operating Partnership in exchange for 900 Units.
- On December 22, 1998, in connection with the Sovran Self Storage, Inc. Dividend Reinvestment and Stock Purchase Plan, the Company transferred $647,030 to the Operating Partnership in exchange for 26,410 Units.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference to "Certain Transactions" in the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 25, 1999.
Part IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as part of this Annual Report on Form 10-K:
1. Financial Statements filed as part of this Annual Report on Form 10-K. (i) Balance Sheets for Years Ended December 31, 1998 and 1997. (ii) Statements of Operations for Years Ended December 31, 1998, 1997, and 1996. (iii) Statements of Partners' Capital of the for Years Ended December 31, 1998, 1997, and 1996. (iv) Statements of Cash Flows for Years Ended December 31, 1998, 1997, and 1996. (v) Selected Financial Data.
2. The following financial statement schedule as of the period ended December 31, 1998 is included in this Annual Report on From 10-K.
Schedule III Real Estate and Accumulated Depreciation.
All other financial schedules are omitted because they are inapplicable, not required, or the information is included elsewhere in the financial statements or the notes thereto.
Exhibits
Exhibit No. Description
3.1 Agreement of Limited Partnership of the Operating Partnership, as amended
3.2* Amended and Restated Articles of Incorporation of the Company
3.3* By-laws of the Company
3.4 Articles Supplementary of the Articles of Incorporation of the Company classifying and designating the Company's Series A Junior Participating Preferred Stock (Incorporated by reference to Exhibit 3.1 to the Company's Form 8A filed December 3, 1996)
10.1 Revolving Credit Agreement between the Company, the Operating Partnership, Fleet National Bank and other lenders named therein
10.2* Form of Non-competition Agreement between the Company and Charles E. Lannon
10.3* Form of Non-competition Agreement between the Company and Robert J. Attea
10.4* Form of Non-competition Agreement between the Company and Kenneth F. Myszka
10.5* Form of Non-competition Agreement between the Company and David L. Rogers
10.6* Sovran Self Storage, Inc. 1995 Award and Option Plan
10.7* 1995 Sovran Self Storage, Inc. Directors' Option Plan
10.8* Sovran Self Storage Incentive Compensation Plan for Executive Officer
10.9* Restricted Stock Agreement between the Company and David L. Rogers
10.10* Form of Supplemental Representations, Warranties and Indemnification Agreement among the Company and Robert J. Attea, Charles E. Lannon, Kenneth F. Myszka and David L. Rogers
10.11* Form of Pledge Agreement among the Company and Robert J. Attea, Charles E. Lannon, Kenneth F. Myszka and David L. Rogers
10.12* Form of Indemnification Agreement between the Company and certain Officers and Directors of the Company
10.13* Form of Subscription Agreement (including Registration Rights Statement) among the Company and subscribers for 422,171 Common Shares
10.14* Form of Registration Rights and Lock-Up Agreement among the Company and Robert J. Attea, Charles E. Lannon, Kenneth F. Myszka and David L. Rogers
10.15* Form of Facilities Services Agreement between the Company and Williamsville Properties, Inc.
10.16** Term Loan Agreement
23 Consent of Independent Auditors
27 Financial Data Schedule
_________________
* Incorporated by reference to the exhibits as filed with the Company's Registration Statement on Form S-11 (File No. 33-91422) filed June 19, 1995.
** Incorporated by reference to Exhibit 10.16 filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-13820)
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Sovran Holdings Inc., as general partner of registrant, certifies that it has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SOVRAN ACQUISITION LIMITED PARTNERSHIP
By: Sovran Holdings, Inc. Its: General Partner
March 31, 1999 By: /S/ David L. Rogers _________________________________ David L. Rogers, Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Sovran Holdings Inc., as general partner of registrant, and in the capacities and on the dates indicated.
Signature Title Date
/s/ Robert J. Attea Chairman of the March 31, 1999 __________________________ Board of Directors, Robert J. Attea Chief Executive Officer and Director (Principal Executive Officer)
/s/ Kenneth F. Myszka President, Chief March 31, 1999 __________________________ Operating Officer Kenneth F. Myszka and Director
/s/David L. Rogers Chief Financial March 31, 1999 __________________________ Officer (Principal David L. Rogers Financial and Accounting Officer)
/s/John Burns Director March 31, 1999 __________________________ John Burns
/s/Michael A. Elia Director March 31, 1999 __________________________ Michael A. Elia
/s/Anthony P. Gammie Director March 31, 1999 __________________________ Anthony P. Gammie
/s/Charles E. Lannon Director March 31, 1999 __________________________ Charles E. Lannon
Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form S-3, No. 333-51169) of Sovran Self Storage, Inc. and Sovran Acquisition Limited Partnership and in the related Prospectus of our report dated January 29, 1999, with respect to the financial statements and schedules included in this Annual Report (Form 10-K) of Sovran Acquisition Limited Partnership.
/s/ Ernst & Young LLP
Buffalo, New York March 26, 1999