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PSA > SEC Filings for PSA > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for PUBLIC STORAGE


6-Nov-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with our financial statements and notes thereto.

Forward Looking Statements: This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements in this document, other than statements of historical fact, are forward-looking statements, which may be identified by the use of the words "expects," "believes," "anticipates," "plans," "would," "should," "may," "estimates" and similar expressions.

These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which may cause our actual results and performance to be materially different from those expressed or implied in the forward-looking statements. Factors and risks that may impact our future results and performance include, but are not limited to, those described in Part I, Item 1A, "Risk Factors" in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on February 25, 2013 and in our other filings with the SEC and the following:

general risks associated with the ownership and operation of real estate, including changes in demand, risks related to development of self-storage facilities, potential liability for environmental contamination, natural disasters and adverse changes in laws and regulations governing property tax, real estate and zoning;

risks associated with downturns in the national and local economies in the markets in which we operate, including risks related to current economic conditions and the economic health of our tenants;

the impact of competition from new and existing self-storage and commercial facilities and other storage alternatives;

difficulties in our ability to successfully evaluate, finance, integrate into our existing operations, and manage acquired properties, or in our ability to find development projects that meet our risk-adjusted yield expectations or to obtain building permits for self-storage activities in certain municipalities, and to complete these projects timely and on budget;

risks associated with international operations including, but not limited to, unfavorable foreign currency rate fluctuations, refinancing risk of affiliate loans from us, and local and global economic uncertainty that could adversely affect our earnings and cash flows;

risks related to our participation in joint ventures;

the impact of the regulatory environment as well as national, state, and local laws and regulations including, without limitation, those governing environmental, taxes and tenant insurance matters and real estate investment trusts ("REITs"), and risks related to the impact of new laws and regulations;

risk of increased tax expense associated either with a possible failure by us to qualify as a REIT, or with challenges to intercompany transactions with our taxable REIT subsidiaries;

changes in federal tax laws related to the taxation of REITs, which could impact our status as a REIT;

disruptions or shutdowns of our automated processes, systems and the Internet or breaches of our data security;


risks associated with the self-insurance of certain business risks, including property and casualty insurance, employee health insurance and workers compensation liabilities;

risks related to the concentration of approximately 20% of our facilities in California;

difficulties in raising capital at a reasonable cost or on other terms acceptable or favorable to us; and

economic uncertainty due to the impact of terrorism or war.

These forward looking statements speak only as of the date of this report or as of the dates indicated in the statements. All of our forward-looking statements, including those in this report, are qualified in their entirety by this statement. We expressly disclaim any obligation to update publicly or otherwise revise any forward-looking statements, whether as a result of new information, new estimates, or other factors, events or circumstances after the date of these forward looking statements, except as required by law. Given these risks and uncertainties, you should not rely on any forward-looking statements in this report, or which management may make orally or in writing from time to time, as predictions of future events or guarantees of future performance.

Critical Accounting Policies

Our MD&A discusses our financial statements, which have been prepared in accordance with United States ("U.S.") generally accepted accounting principles ("GAAP"). Our financial statements are affected by our judgments, assumptions and estimates. The notes to our September 30, 2013 financial statements, primarily Note 2, summarize our significant accounting policies.

We believe the following are our critical accounting policies, because they have a material impact on the portrayal of our financial condition and results, and they require us to make judgments and estimates about matters that are inherently uncertain.

Income Tax Expense: We have elected to be treated as a real estate investment trust ("REIT"), as defined in the Internal Revenue Code. As a REIT, we do not incur federal income tax on our REIT taxable income (generally, net rents and gains from real property, dividends, and interest) that is fully distributed each year (for this purpose, certain distributions paid in a subsequent year may be considered), and if we meet certain organizational and operational rules. We believe we have met these REIT requirements for all periods presented herein. Accordingly, we have recorded no federal income tax expense related to our REIT taxable income.

Our evaluation that we have met the REIT requirements could be incorrect, because compliance with the tax rules requires factual determinations, and circumstances we have not identified could result in noncompliance with the tax requirements in current or prior years. For any taxable year that we fail to qualify as a REIT and for which applicable statutory relief provisions did not apply, we would be taxed at the regular corporate rates on all of our taxable income for at least that year and the ensuing four years, we could be subject to penalties and interest, and our net income would be materially different from the amounts estimated in our financial statements.

In addition, our taxable REIT subsidiaries are taxable as regular corporations. To the extent that amounts paid to us by our taxable REIT subsidiaries are determined by the taxing authorities to be in excess of amounts that would be paid under similar arrangements among unrelated parties, we could be subject to a 100% penalty tax on the excess payments. Such a penalty tax could have a material adverse impact on our net income.

Impairment of Long-Lived Assets: The analysis of impairment of our long-lived assets involves identification of indicators of impairment, projections of future operating cash flows, and estimates of fair values, all of which require significant judgment and subjectivity. Others could come to materially different conclusions. In addition, we may not have identified all current facts and circumstances that may affect impairment. Any unidentified impairment loss, or change in conclusions, could have a material adverse impact on our net income.


Accruals for Operating Expenses: Certain of our expenses are estimated based upon assumptions regarding past and future trends, such as losses for workers compensation, property taxes, and estimated claims for our tenant reinsurance program. In certain jurisdictions we do not receive property tax bills for the current fiscal year until after our earnings are finalized, and as a result, we must estimate property tax expense based upon anticipated implementation of regulations and trends. If our related estimates and assumptions are incorrect, our operating expenses could be misstated.

Accruals for Contingencies: We may be currently liable for payments, due to legal or business risks, that we have not accrued, either because they are not probable or not estimable, or because we are not currently aware of our liability. We may have to accrue additional amounts for these payments due to the results of further investigation, the litigation process, or otherwise. Such accruals could have a material adverse impact on our net income.

Recording the fair value of acquired real estate facilities: In accounting for facilities acquired from third parties, we estimate the fair value of the land, buildings and intangible assets acquired. Such estimates are based upon many assumptions and judgments, including i) expected rates of return and capitalization rates on real estate assets, ii) estimated costs to replace acquired buildings and equipment in their current state, iii) comparisons of the acquired underlying land parcels to recent land transactions, and iv) future cash flows from the real estate and the existing tenant base. Others could come to materially different conclusions as to the estimated fair values, which would result in different depreciation and amortization expense, gains and losses on sale of real estate assets, and real estate and intangible assets.

MD&A Overview

Our domestic self-storage facilities generated 93% of our revenues for the nine months ended September 30, 2013, and also generated most of our net income and cash flow from operations. A significant portion of management time is devoted to maximizing cash flows from our existing self-storage facilities, as well as seeking additional investments in self-storage facilities.

Most of our facilities compete with other well-managed and well-located competitors and we are subject to general economic conditions, particularly those that affect the spending habits of consumers and moving trends. We believe that our centralized information networks, national telephone and online reservation system, the brand name "Public Storage," and our economies of scale enable us to meet such challenges effectively.

During the first nine months of 2013, we acquired 32 self-storage facilities from third parties for approximately $392 million. During the last three months of December 31, 2013, we expect to complete the acquisition of 88 self-storage facilities at a cost of approximately $754 million. A total of $324 million of these acquisitions (44 facilities) have been completed as of November 5, 2013. We expect to continue to seek to acquire additional self-storage facilities from third parties. There is significant competition to acquire existing facilities and there can be no assurance that we will be able to acquire additional facilities at prices we will find attractive.

As of September 30, 2013, we have development and expansion projects which will add approximately 1.6 million net rentable square feet of storage space at a total cost of approximately $188 million. A total of $46 million in costs were incurred through September 30, 2013, with the remaining costs expected to be incurred primarily in the last three months of 2013 and in 2014.

We expect to continue to seek additional development projects; however, the level of future development may be limited due to various constraints such as difficulty in finding available sites that meet our risk-adjusted yield expectations, as well as challenges in obtaining building permits for self-storage activities in certain municipalities.

We also have equity investments in Shurgard Europe and PS Business Parks, Inc. ("PSB"). During the three months ended September 30, 2013, we increased our ownership in PSB by acquiring 406,748 shares of PSB common stock in open-market transactions for an aggregate cost of $29.8 million. On November 7, 2013, we expect to acquire 950,000 shares of PSB common stock at $79.25 per share (a total of $75.3 million), in a private placement


that is expected to close concurrently with PSB's public offering of approximately 1.3 million common shares (prior to exercise of the underwriter's over-allotment option) at $79.25 per share. We may invest further in these entities in the future.

At September 30, 2013, we had a total of $57 million in cash and an undrawn $300 million line of credit. We expect our joint venture partner in Shurgard Europe to acquire 51% of our loan receivable from Shurgard Europe for approximately $214 million during the three months ending December 31, 2013; however, completion of this transaction is subject to contingencies. We expect that this liquidity, combined with retained operating cash flow during the three months ending December 31, 2013, will not be sufficient to meet our capital requirements through the end of 2013. See Liquidity and Capital Resources.

Results of Operations

Operating results for the Three Months Ended September 30, 2013 and 2012

For the three months ended September 30, 2013, net income allocable to our common shareholders was $231.4 million or $1.34 per diluted common share, compared to $202.5 million or $1.18 per diluted common share for the same period in 2012, representing an increase of $28.9 million or $0.16 per diluted common share. This increase is due primarily to (i) a $27.7 million increase in self-storage net operating income, (ii) a $12.9 million reduction in income allocated to preferred shareholders due to redemptions, including PSB, and (iii) a $7.1 million increase from foreign currency exchange gains, offset partially by (iv) a $12.8 million reduction in gains on sale of real estate assets, including discontinued operations and Shurgard Europe and (v) a $6.6 million increase in depreciation.

Operating results for the Nine Months Ended September 30, 2013 and 2012

For the nine months ended September 30, 2013, net income allocable to our common shareholders was $601.0 million or $3.48 per diluted common share, compared to $460.2 million or $2.68 per diluted common share for the same period in 2012, representing an increase of $140.8 million or $0.80 per diluted common share. This increase is due primarily to a $86.5 million increase in self-storage net operating income, combined with a $56.9 million reduction in income allocated to preferred shareholders due to redemptions, including PSB.

Funds from Operations and Core Funds from Operations

Funds from Operations ("FFO") is a non-GAAP term defined by the National Association of Real Estate Investment Trusts, and generally represents net income before depreciation, gains and losses, and impairment charges with respect to real estate assets. We present FFO and FFO per share because we consider FFO to be an important measure of the performance of real estate companies, as do many analysts in evaluating our Company. We believe that FFO is a helpful measure of a REIT's performance since FFO excludes depreciation, which is included in computing net income and assumes the value of real estate diminishes predictably over time. We believe that real estate values fluctuate due to market conditions and in response to inflation. FFO computations do not consider scheduled principal payments on debt, capital improvements, distributions and other obligations of the Company. FFO and FFO per share is not a substitute for our cash flow or net income per share as a measure of our liquidity or operating performance or our ability to pay dividends. Because other REITs may not compute FFO in the same manner, FFO may not be comparable among REITs.

For the three months ended September 30, 2013, FFO was $2.00 per diluted common share, as compared to $1.73 for the same period in 2012, representing an increase of $0.27 per diluted common share.

For the nine months ended September 30, 2013, FFO was $5.40 per diluted common share, as compared to $4.46 for the same period in 2012, representing an increase of $0.94 per diluted common share.

The following table reconciles from our net income to FFO and FFO per diluted common share:


                                        Three Months Ended          Nine Months Ended
                                           September 30,              September 30,
                                         2013         2012          2013          2012


Net income                            $ 285,628    $ 264,819    $   759,554    $  670,472
Adjust for amounts not included in
FFO:
Depreciation and amortization,
including discontinued
operations                               96,537       89,991        278,475       265,517
Depreciation from unconsolidated real
estate
investments                              18,708       18,391         55,769        56,955
Gains on sale of real estate
investments                                (168)     (13,010)          (168)      (14,273)
FFO allocable to equity holders         400,705      360,191      1,093,630       978,671
Less allocation of FFO to:
Noncontrolling equity interests          (1,938)      (1,730)        (5,339)       (4,950)
Preferred shareholders -
distributions                           (51,907)     (49,267)      (152,404)     (156,272)
Preferred shareholders - redemptions           -     (11,350)              -      (49,677)
Restricted share unitholders             (1,401)      (1,198)        (3,802)       (2,990)
FFO allocable to common shares        $ 345,459    $ 296,646    $   932,085    $  764,782
Diluted weighted average common
shares                                  172,793      171,700        172,651       171,558
FFO per share                         $    2.00    $    1.73    $      5.40    $     4.46

In addition to FFO, we often discuss "Core FFO" per share which is also a non-GAAP measure that represents FFO per share, adjusted to exclude the impact of (i) foreign currency exchange gains and losses, consisting of a gain of $16.1 million and $9.3 million for the three and nine months ended September 30, 2013, respectively (a gain of $9.0 million and a loss of $2.5 million for the same periods in 2012), (ii) the impact of EITF D-42, including our equity share from PSB, representing charges totaling $12.9 million and $56.9 million, respectively, for the three and nine months ended September 30, 2012 (none for the same periods in 2013), and (iii) other items (including our equity share from PSB and Shurgard Europe) such as facility closure charges, contingency accruals, and costs incurred in acquiring real estate facilities. We believe Core FFO is a helpful measure in understanding our ongoing earnings and cash flow. We also believe that the analyst community, likewise, reviews our Core FFO and Core FFO per share (or similar measures using different terminology). Core FFO is not a substitute for net income, earnings per share or cash flow from operations. Because other REITs may not compute Core FFO in the same manner as we do, may not use the same terminology, or may not present such a measure, Core FFO may not be comparable among REITs.

The following table reconciles from FFO per share to Core FFO per share:

                              Three Months Ended September 30,          Nine Months Ended September 30,
                                                        Percentage                               Percentage
                              2013           2012         Change        2013           2012        Change

FFO per share              $     2.00     $     1.73        15.6%    $     5.40     $    4.46        21.1%
Eliminate the per share
impact of items
excluded from Core FFO:
Foreign currency exchange
(gain) loss                     (0.09)         (0.05)                     (0.05)         0.01
Application of EITF D-42             -          0.08                           -         0.33
Other items                      0.01               -                      0.01          0.02
Core FFO per share         $     1.92     $     1.76         9.1%    $     5.36     $    4.82        11.2%


Real Estate Operations

Self-Storage Operations: Our self-storage operations represent 93% of our revenues for the nine months ended September 30, 2013. Our self-storage operations are analyzed in two groups: (i) the Same Store Facilities, representing the facilities that we have owned and operated on a stabilized basis since January 1, 2011, and (ii) all other facilities, which are newly acquired, newly developed, or recently expanded facilities (the "Non Same Store Facilities").

Self-Storage
Operations
Summary                  Three Months Ended September 30,          Nine Months Ended September 30,
                                                  Percentage                                 Percentage
                          2013          2012        Change         2013           2012         Change

                                                (Dollar amounts in thousands)
Revenues:
Same Store Facilities $   441,011    $ 418,085         5.5%    $ 1,270,761    $ 1,206,309         5.3%
Non Same Store
Facilities                 36,967       27,084        36.5%         98,458         73,479        34.0%
Total rental income       477,978      445,169         7.4%      1,369,219      1,279,788         7.0%
Cost of operations:
Same Store Facilities     124,798      122,987         1.5%        378,743        382,524        (1.0)%
Non Same Store
Facilities                 11,953        8,631        38.5%         31,138         24,389        27.7%
Total cost of
operations                136,751      131,618         3.9%        409,881        406,913         0.7%
Net operating income
(a):
Same Store Facilities     316,213      295,098         7.2%        892,018        823,785         8.3%
Non Same Store
Facilities                 25,014       18,453        35.6%         67,320         49,090        37.1%
Total net operating
income                    341,227      313,551         8.8%        959,338        872,875         9.9%
Depreciation and
amortization expense:
Same Store Facilities     (76,043)     (78,713)       (3.4)%      (229,504)      (236,897)       (3.1)%
Non Same Store
Facilities                (19,798)     (10,481)       88.9%        (46,888)       (26,212)       78.9%
Total depreciation
and
amortization expense      (95,841)     (89,194)        7.5%       (276,392)      (263,109)        5.0%
Total net income      $   245,386    $ 224,357         9.4%    $   682,946    $   609,766        12.0%


Number of facilities
at period end:
Same Store Facilities                                                1,949          1,949             -
Non Same Store
Facilities                                                             148            106        39.6%
Net rentable square
footage at period end
(in thousands):
Same Store Facilities                                              122,823        122,823             -
Non Same Store
Facilities                                                          11,808          8,054        46.6%

(a) See "Net Operating Income" below for further information regarding this non-GAAP measure.


Same Store Facilities

The Same Store Facilities represent those facilities that have been owned and operated on a stabilized basis since January 1, 2011 and therefore provide meaningful comparisons for 2012 and 2013. The following table summarizes the historical operating results of these 1,949 facilities (122.8 million net rentable square feet) that represent approximately 91% of the aggregate net rentable square feet of our U.S. consolidated self-storage portfolio at September 30, 2013.

Selected Operating Data for the
Same Store Facilities (1,949

facilities)
                                       Three Months Ended September 30,           Nine Months Ended September 30,
                                                                 Percentage                                 Percentage
                                       2013           2012         Change         2013           2012         Change

                                             (Dollar amounts in thousands, except weighted average amounts)
Revenues:
Rental income                      $   419,022    $   396,879         5.6%    $ 1,207,932    $ 1,145,517         5.4%
Late charges and administrative
fees                                    21,989         21,206         3.7%         62,829         60,792         3.4%
Total revenues (a)                     441,011        418,085         5.5%      1,270,761      1,206,309         5.3%

Cost of operations:
Property taxes                          43,652         40,703         7.2%        132,441        125,896         5.2%
On-site property manager payroll        24,567         24,797        (0.9)%        75,791         75,276         0.7%
Supervisory payroll                      8,303          8,229         0.9%         26,088         25,766         1.2%
Repairs and maintenance                  9,689          8,500        14.0%         29,599         31,178        (5.1)%
Utilities                               10,045         10,194        (1.5)%        27,862         27,942        (0.3)%
Advertising and selling expense          8,385         10,216       (17.9)%        22,250         31,333       (29.0)%
Other direct property costs             12,259         12,775        (4.0)%        37,299         37,570        (0.7)%
Allocated overhead                       7,898          7,573         4.3%         27,413         27,563        (0.5)%
Total cost of operations (a)           124,798        122,987         1.5%        378,743        382,524        (1.0)%
Net operating income (b)               316,213        295,098         7.2%        892,018        823,785         8.3%
Depreciation and amortization
expense                                (76,043)       (78,713)       (3.4)%      (229,504)      (236,897)       (3.1)%
Net income                         $   240,170    $   216,385        11.0%    $   662,514    $   586,888        12.9%

Gross margin (before depreciation
and
amortization)                          71.7%          70.6%           1.6%        70.2%          68.3%           2.8%

Weighted average for the period:
Square foot occupancy (c)              94.4%          93.0%           1.5%        93.4%          91.9%           1.6%
Realized annual rental income per:
Occupied square foot (d)           $     14.46    $     13.90         4.0%    $     14.04    $     13.53         3.8%
Available square foot ("REVPAF")
(d)                                $     13.65    $     12.93         5.6%    $     13.11    $     12.44         5.4%
Weighted average at September 30:
Square foot occupancy                                                             93.6%          92.5%           1.2%
Annual contract rent per occupied
square foot (e)                                                               $     15.20    $     14.64         3.8%

(a) Revenues and cost of operations do not include ancillary revenues and expenses generated at the facilities with respect to tenant reinsurance and retail sales.

(b) See "Net Operating Income" below for a reconciliation of this non-GAAP measure to our operating income in our income statements for the three and nine months ended September 30, 2013 and 2012.

(c) Square foot occupancies represent weighted average occupancy levels over the entire period.

. . .

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