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PSA > SEC Filings for PSA > Form 10-K on 26-Feb-2014All Recent SEC Filings

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Form 10-K for PUBLIC STORAGE


26-Feb-2014

Annual Report


ITEM 7. 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.

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 December 31, 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.

Accrual for Uncertain and Contingent Liabilities: We accrue for certain contingent and other liabilities that have significant uncertain elements, such as property taxes, workers compensation claims, tenant reinsurance claims, as well as other legal claims and disputes involving customers, employees, governmental agencies and other third parties. Such liabilities we are aware of are estimated based upon many factors such as assumptions of past and future trends and our evaluation of likely outcomes. However, the estimates of known liabilities could be incorrect or we may not be aware of all such liabilities, in which case our accrued liabilities and net income could be misstated.


Recording the fair value of acquired real estate facilities: In accounting for facilities acquired from third parties, we estimate the fair values 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 year ended December 31, 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 2013, we acquired 121 self-storage facilities for approximately $1.2 billion, substantially more than we had acquired in total in 2010, 2011 and 2012 (an aggregate of 77 facilities for $546 million). In 2013, we took advantage of a significant increase in properties being marketed for sale, which we believe was primarily driven by easier access to capital in the current low interest rate environment and improved property valuations. 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 December 31 2013, we had development and expansion projects which will add approximately 1.8 million net rentable square feet of storage space at $196 million. 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 year ended December 31, 2013, we increased our ownership interest in PSB by acquiring 1,356,748 shares of PSB common stock in open-market transactions and directly from PSB, for an aggregate cost of $105.0 million. We may invest further in these entities in the future.

As of December 31, 2013, our capital commitments for 2014 exceed our expected capital resources. As of December 31, 2013, our capital resources consist of (i) approximately $250 million of available borrowing capacity on our revolving line of credit, (ii) $216.2 million of cash proceeds from the sale of 51% of a loan we have provided to Shurgard Europe which we received in January 2014, and (iii) $250 million of expected 2014 retained operating cash flow. Retained operating cash flow represents our expected 2014 cash flow provided by operating activities, after deducting estimated 2014 distributions to our common and preferred shareholders, and estimated 2014 capital expenditure requirements.

At December 31, 2013, we had estimated 2014 capital commitments of $726.2 million of debt maturities, and approximately $145 million of remaining spend on our development pipeline. In addition, we expect that our capital commitments will continue to grow during 2014 as we continue to seek additional development and acquisition opportunities.


We believe we have a variety of possibilities to bridge the gap between our capital resources and commitments which may include raising capital through the issuance of common or preferred securities, issuing debt, expanding the borrowing capacity of our credit facility, or entering into joint venture arrangements to acquire or develop facilities. See Liquidity and Capital Resources for further information regarding our 2014 capital requirements.

Results of Operations

Operating results for 2013 as compared to 2012

For the year ended December 31, 2013, net income allocable to our common shareholders was $844.7 million or $4.89 per diluted common share, compared to $669.7 million or $3.90 per diluted common share for the same period in 2012, representing an increase of $175.0 million or $0.99 per diluted common share. This increase is due primarily to (i) a $124.6 million increase in self-storage net operating income, (ii) a $68.9 million reduction in income allocated to preferred shareholders due to redemptions, including our equity share of PSB, (iii) an $8.2 million increase from foreign currency exchange gains, offset partially by (iv) a $29.6 million increase in depreciation and amortization associated with acquired real estate facilities.

Operating results for 2012 as compared to 2011

For the year ended December 31, 2012, net income allocable to our common shareholders was $669.7 million or $3.90 per diluted common share, compared to $561.7 million or $3.29 per diluted common share for the same period in 2011, representing an increase of $108.0 million or $0.61 per diluted common share. This increase is due to (i) a $102.5 million increase in self-storage net operating income, (ii) a $19.6 million reduction in distributions to preferred shareholders due primarily to lower average coupon rates, and (iii) a $16.2 million increase resulting from foreign currency exchange gains and losses in translating our Euro-denominated loan receivable from Shurgard Europe into U.S. Dollars, offset partially by (iv) a $36.3 million decrease due to the application of EITF D-42 to our, and our equity share of PSB's, redemptions of preferred securities.

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 year ended December 31, 2013, FFO was $7.53 per diluted common share, as compared to $6.31 for the same period in 2012, representing an increase of $1.22 per diluted common share.

For the year ended December 31, 2012, FFO was $6.31 per diluted common share, as compared to $5.67 for the same period in 2011, representing an increase of $0.64 per diluted common share.

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


                                                           Year Ended December 31,
                                                   2013                2012              2011
                                                (Amounts in thousands, except per share data)

Net income                                   $     1,057,531     $       943,035     $   836,459
Adjust for amounts not included in FFO:
Depreciation and amortization, including
discontinued
operations                                           387,402             358,103         358,525
Depreciation from unconsolidated real
estate
investments                                           75,458              75,648          64,677
Gains on sale of real estate investments,
including our equity share                            (4,120)            (14,778)        (12,797)
FFO allocable to equity holders                    1,516,271           1,362,008       1,246,864
Less allocation of FFO to:
Noncontrolling equity interests                       (7,275)             (6,828)        (15,539)
Preferred shareholders - distributions              (204,312)           (205,241)       (224,877)
Preferred shareholders - redemptions                        -            (61,696)        (35,585)
Restricted share unitholders                          (5,173)             (4,247)         (2,817)
FFO allocable to common shares               $     1,299,511     $     1,083,996     $   968,046
Diluted weighted average common shares               172,688             171,664         170,750
FFO per share                                $          7.53     $          6.31     $      5.67

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, representing gains of $17.1 million and $8.9 million in 2013 and 2012, respectively, and a loss of $7.3 million for 2011, (ii) the impact of EITF D-42, including our equity share from PSB, representing charges totaling $68.9 million and $32.6 million for 2012 and 2011, respectively, (none for 2013) and (iii) other items. 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 FFO per share to Core FFO per share:

                                    Year Ended December 31,              Year Ended December 31,
                                                       Percentage                           Percentage
                                 2013        2012        Change       2012        2011        Change

FFO per share                  $   7.53    $   6.31        19.3%    $   6.31    $   5.67        11.3%
Eliminate the per share impact
of
items excluded from Core FFO:
Foreign currency exchange
(gain) loss                       (0.10)      (0.05)                   (0.05)       0.04
Application of EITF D-42               -       0.40                     0.40        0.19
Other items                        0.01        0.02                     0.02        0.03
Core FFO per share             $   7.44    $   6.68        11.4%    $   6.68    $   5.93        12.6%


Real Estate Operations

Self-Storage Operations: Our self-storage operations represent 93% of our revenues for the year ended December 31, 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                       Year Ended December 31,                    Year Ended December 31,
                                                    Percentage                                 Percentage
                          2013           2012         Change         2012           2011         Change

                                                 (Dollar amounts in thousands)
Revenues:
Same Store Facilities $ 1,703,294    $ 1,616,798         5.3%    $ 1,616,798    $ 1,544,543         4.7%
Non Same Store
Facilities                146,589        102,067        43.6%        102,067         77,256        32.1%
Total rental income     1,849,883      1,718,865         7.6%      1,718,865      1,621,799         6.0%
Cost of operations:
Same Store Facilities     478,978        485,460        (1.3)%       485,460        496,569        (2.2)%
Non Same Store
Facilities                 45,108         32,181        40.2%         32,181         26,544        21.2%
Total cost of
operations                524,086        517,641         1.2%        517,641        523,113        (1.0)%
Net operating income
(a):
Same Store Facilities   1,224,316      1,131,338         8.2%      1,131,338      1,047,974         8.0%
Non Same Store
Facilities                101,481         69,886        45.2%         69,886         50,712        37.8%
Total net operating
income                  1,325,797      1,201,224        10.4%      1,201,224      1,098,686         9.3%
Depreciation and
amortization expense:
Same Store Facilities    (305,270)      (314,428)       (2.9)%      (314,428)      (322,467)       (2.5)%
Non Same Store
Facilities                (79,353)       (40,543)       95.7%        (40,543)       (32,848)       23.4%
Total depreciation
and
amortization expense     (384,623)      (354,971)        8.4%       (354,971)      (355,315)       (0.1)%
Total net income      $   941,174    $   846,253        11.2%    $   846,253    $   743,371        13.8%

Number of facilities at period
end:
Same Store Facilities       1,949          1,949             -         1,949          1,949             -
Non Same Store
Facilities                    238            116       105.2%            116             89        30.3%
Net rentable square
footage at period end
(in thousands):
Same Store Facilities     122,823        122,823             -       122,823        122,823             -
Non Same Store
Facilities                 17,464          8,814        98.2%          8,814          6,638        32.8%

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

Net income from our Self-Storage operations has increased 11.2% in 2013 as compared to 2012 and 13.8% in 2012 as compared to 2011. These increases are due to improvements in our Same Store Facilities, as well as the acquisitions of new facilities and the fill-up of unstabilized facilities.


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 2011, 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 88% of the aggregate net rentable square feet of our U.S. consolidated self-storage portfolio at December 31, 2013.

Selected Operating Data for
the Same Store Facilities
(1,949 facilities)
                                     Year Ended December 31,                    Year Ended December 31,
                                                           Percentage                                 Percentage
                                 2013           2012         Change         2012           2011         Change

                                       (Dollar amounts in thousands, except weighted average amounts)
Revenues:
Rental income                $ 1,619,533    $ 1,536,517         5.4%    $ 1,536,517    $ 1,465,038         4.9%
Late charges and
administrative fees               83,761         80,281         4.3%         80,281         79,505         1.0%
Total revenues (a)             1,703,294      1,616,798         5.3%      1,616,798      1,544,543         4.7%

Cost of operations:
Property taxes                   160,027        152,191         5.1%        152,191        147,806         3.0%
On-site property manager
payroll                           97,563         98,326        (0.8)%        98,326        101,445        (3.1)%
Supervisory payroll               33,766         33,306         1.4%         33,306         32,187         3.5%
Repairs and maintenance           39,401         40,079        (1.7)%        40,079         45,406       (11.7)%
Utilities                         36,387         36,370         0.0%         36,370         37,873        (4.0)%
Advertising and selling
expense                           27,083         38,871       (30.3)%        38,871         42,846        (9.3)%
Other direct property costs       49,340         50,361        (2.0)%        50,361         53,725        (6.3)%
Allocated overhead                35,411         35,956        (1.5)%        35,956         35,281         1.9%
Total cost of operations (a)     478,978        485,460        (1.3)%       485,460        496,569        (2.2)%
Net operating income (b)       1,224,316      1,131,338         8.2%      1,131,338      1,047,974         8.0%
Depreciation and
amortization expense            (305,270)      (314,428)       (2.9)%      (314,428)      (322,467)       (2.5)%
Net income                   $   919,046    $   816,910        12.5%    $   816,910    $   725,507        12.6%

Gross margin (before
depreciation and
amortization)                      71.9%          70.0%         2.7%          70.0%          67.9%         3.1%

Weighted average for the
period:
Square foot occupancy (c)          93.3%          91.9%         1.5%          91.9%          91.3%         0.7%
Realized annual rental
income per:
Occupied square foot (d)     $     14.13    $     13.61         3.8%    $     13.61    $     13.06         4.2%
Available square foot
("REVPAF") (d)               $     13.19    $     12.51         5.4%    $     12.51    $     11.93         4.9%
Weighted average at December
31:
Square foot occupancy              91.8%          91.4%         0.4%          91.4%          89.6%         2.0%
Annual contract rent per
occupied square foot (e)     $     15.02    $     14.43         4.1%    $     14.43    $     14.02         2.9%

(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 years ended December 31, 2013, 2012 and 2011.

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


(d) Realized annual rent per occupied square foot is computed by dividing annualized rental income, before late charges and administrative fees, by the weighted average occupied square feet for the period. Realized annual rent per available square foot ("REVPAF") is computed by dividing annualized rental income, before late charges and administrative fees, by the total available net rentable square feet for the period. These measures exclude late charges and administrative fees in order to provide a better measure of our ongoing level of revenue. Late charges are dependent upon the level of delinquency, and administrative fees are dependent upon the level of move-ins. In addition, the rates charged for late charges and administrative fees can vary independently from rental rates. These measures take into consideration promotional discounts, which reduce rental income.

(e) Contract rent represents the applicable contractual monthly rent charged to our customers, excluding the impact of promotional discounts, late charges, and administrative fees.

Analysis of Same Store Revenue

Revenues generated by our Same Store Facilities increased by 5.3% in 2013 as compared to 2012 due to a 1.5% increase in average occupancy and a 3.8% increase in realized rent per occupied square foot. Revenues generated by our Same Store Facilities increased by 4.7% in 2012 as compared to 2011 due to a 0.7% increase in average occupancy and a 4.2% increase in realized rent per occupied square foot. The increase in realized rent per occupied square foot in both periods was due primarily to annual rent increases given to customers that have been renting with us longer than one year, and to a lesser extent, reduced promotional discounts given to new customers.

Same Store average occupancy increased from 91.3% in 2011, to 91.9% in 2012, and to 93.3% in 2013, representing increases of 0.7% in 2012 and 1.5% in 2013. The year over year increases began primarily late in the fourth quarter of 2012, as we implemented more aggressive pricing strategies in the seasonally slow first and fourth quarters. The occupancy spread narrowed in the fourth quarter of 2013 and is expected to continue to narrow in 2014, due to more difficult comparisons.

Our future rental growth will be dependent upon many factors for each market that we operate in, including demand for self-storage space, the level of competitor supply of self-storage space, our ability to increase rental rates to new and existing customers, the level of promotional activities required, and the average length of stay of our customers.

Increasing rental rates to existing customers, generally on an annual basis, is a key component of our revenue growth. We determine the level of rental increases based upon our expectations regarding the impact of existing tenant rate increases on incremental move-outs. We expect to pass similar rent increases to long-term customers in 2014, as we did in 2013.

We believe that high occupancies help maximize our rental revenue. We seek to maintain an average occupancy level of at least 90%, by regularly adjusting the rental rates and promotions offered to attract new customers as well as adjusting our marketing efforts on both television and the Internet in order to generate sufficient move-in volume to replace customers that vacate. Demand fluctuates due to various local and regional factors, including the overall economy. Demand is higher in the summer months than in the winter months and, as a result, rental rates charged to new customers are typically higher in the summer months than in the winter months.

During 2013, 2012 and 2011, the average annualized contractual rates per occupied square foot for customers that moved in were $12.97, $12.76 and $12.89, respectively, and for customers that vacated were $13.76, $13.54 and $13.24, respectively. Promotional discounts, generally representing a one-month reduction in contractual rents, given in the first month of tenancy, were $79.3 million, $87.9 million and $96.6 million in 2013, 2012 and 2011, respectively. Promotional discounts have declined due to higher occupancies.

We believe that the current trends in move-in, move-out, in place contractual rents and occupancy levels are consistent with our expectation of continued revenue growth in 2014. However, such trends, when viewed in the short-run, are volatile and not necessarily predictive of our revenues going forward because . . .

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