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PSA > SEC Filings for PSA > Form 10-Q on 5-May-2014All Recent SEC Filings

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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, 2014 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 customers;

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 and developed properties;

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 or state tax laws related to the taxation of REIT's, 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;

difficulties in raising capital at a reasonable cost; 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 nor 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 March 31, 2014 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 three months ended March 31, 2014, 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 March 31, 2014, we had development and expansion projects which will add approximately 1.9 million net rentable square feet of storage space and will cost approximately $195 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 investment 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 March 31, 2014, our capital resources totaled approximately $625 million, consisting of (i) cash and cash equivalents totaling $101 million, (ii) approximately $285 million of available borrowing capacity on our revolving line of credit, (iii) $49 million in net proceeds from the issuance of 2.0 million additional depositary shares of our Series Y Preferred Shares on April 14, 4014, and (iv) $190 million of retained operating cash flow for the remainder of 2014. Retained operating cash flow represents our expected cash flow provided by operating activities, after deducting estimated distributions to our common and preferred shareholders, and estimated capital expenditure requirements for the nine months ending December 31, 2014.

At March 31, 2014, we had estimated remaining 2014 capital commitments totaling approximately $586 million, consisting of $372 million to repay our term loan, $25 million in maturities on notes payable,

$32 million in property acquisitions, as well as approximately $157 million of remaining spend on our development pipeline. In addition, we expect that our capital commitments will continue to grow during the remainder of 2014 as we continue to seek additional development and acquisition opportunities.

We believe we have a variety of possibilities to bridge any 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 remaining 2014 capital requirements and anticipated sources of capital to fund such requirements.

Results of Operations

Operating Results for the Three Months Ended March 31, 2014 and 2013

For the three months ended March 31, 2014, net income allocable to our common shareholders was $174.1 million or $1.01 per diluted common share, compared to $161.9 million or $0.94 per diluted common share for the same period in 2013, representing an increase of $12.2 million or $0.07 per diluted common share. This increase is due primarily to a $30.8 million increase in self-storage net operating income, offset partially by an $18.0 million increase in depreciation and amortization associated with acquired real estate facilities.

Our self-storage net operating income increased $30.8 million in the three months ended March 31, 2014 as compared to the same period in 2013, including $16.0 million for our Same Store Facilities and $14.8 million for our non-Same Store Facilities. Revenues for the Same Store Facilities increased 5.1% or $21.3 million in the quarter ended March 31, 2014 as compared to the same period in 2013, due to higher realized annual rent per occupied square foot and higher average occupancy. Cost of operations for the Same Store Facilities increased by 4.0% or $5.3 million in the quarter ended March 31, 2014 as compared to the same period in 2013, due primarily to weather related increases in snow removal and utilities expense and increased property tax expense, offset partially by lower advertising and selling costs. The increase in net operating income for the non-Same Store Facilities is due primarily to the impact of the acquisition of 121 self-storage facilities from third parties since January 1, 2013.

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 March 31, 2014, FFO was $1.74 per diluted common share, as compared to $1.57 for the same period in 2013, representing an increase of $0.17 per diluted common share.

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

                                                        Three Months Ended March 31,
                                                       2014                       2013

                                                (Amounts in thousands, except per share data)

Computation of FFO per Share:

Net income allocable to common shareholders   $             174,052      $             161,936
Eliminate items excluded from FFO:
Depreciation and amortization                               109,021                     91,001
Depreciation from unconsolidated real
estate investments                                           19,671                     18,903
Depreciation allocated to noncontrolling
interests and restricted share unitholders                   (1,128)                    (1,015)
Gains on sale of real estate investments,
including our equity share                                      (87)                          -
FFO allocable to common shares                $             301,529      $             270,825
Diluted weighted average common shares                      172,809                    172,514
FFO per share                                 $                1.74      $                1.57

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 losses, consisting of a loss of $2.3 million and $12.7 million for the three months ended March 31, 2014 and March 31, 2013, respectively, and (ii) other items, comprised primarily of a $7.8 million accrual related to a contingent legal settlement included in ancillary cost of operations for the three months ended March 31, 2014, and our $1.4 million share of charges incurred by Shurgard Europe in closing a facility during the same period in 2013. We believe Core FFO is a helpful measure in understanding our ongoing earnings and cash flow. We also believe that the analyst community 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 real estate investment trusts ("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:

                                           Three Months Ended March 31,
                                          2014         2013       Change

FFO per share                           $   1.74     $  1.57        10.8%
Eliminate the per share impact of
items excluded from Core FFO:
Foreign currency exchange loss              0.01        0.07
Other items                                 0.05        0.01
Core FFO per share                      $   1.80     $  1.65         9.1%

Real Estate Operations

Self-Storage Operations: Our self-storage operations represent 93% of our revenues for the three months ended March 31, 2014. 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, 2012, 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 March 31,
                                       2014               2013             Change

                                            (Dollar amounts in thousands)
Same Store Facilities             $      440,622     $      419,309            5.1%
Non Same Store Facilities                 44,965             20,356          120.9%
Total rental income                      485,587            439,665           10.4%
Cost of operations:
Same Store Facilities                    139,529            134,205            4.0%
Non Same Store Facilities                 16,539              6,788          143.7%
Total cost of operations                 156,068            140,993           10.7%
Net operating income (a):
Same Store Facilities                    301,093            285,104            5.6%
Non Same Store Facilities                 28,426             13,568          109.5%
Total net operating income               329,519            298,672           10.3%
Total depreciation and amortization expense:
Same Store Facilities                    (79,158)           (79,742)          (0.7)%
Non Same Store Facilities                (29,175)           (10,560)         176.3%
Total depreciation and
amortization expense                    (108,333)           (90,302)          20.0%
Total net income                  $      221,186     $      208,370            6.2%

Number of facilities at period end:
Same Store Facilities                      1,983              1,983                -
Non Same Store Facilities                    206                 84          145.2%
Net rentable square footage at
period end (in thousands):
Same Store Facilities                    125,492            125,492                -
Non Same Store Facilities                 15,130              6,294          140.4%

(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, 2012 and therefore provide meaningful comparisons for 2013 and 2014. The following table summarizes the historical operating results of these 1,983 facilities (125.5 million net rentable square feet) that represent approximately 89% of the aggregate net rentable square feet of our U.S. consolidated self-storage portfolio at March 31, 2014.

Selected Operating Data for the Same
Store Facilities (1,983 facilities)
                                                        Three Months Ended March 31,
                                               2014                      2013                Change

                                       (Dollar amounts in thousands, except weighted average amounts)
Rental income                          $            418,489      $            398,305           5.1%
Late charges and administrative fees                 22,133                    21,004           5.4%
Total revenues (a)                                  440,622                   419,309           5.1%

Cost of operations:
Property taxes                                       47,602                    45,633           4.3%
On-site property manager payroll                     26,823                    26,372           1.7%
Supervisory payroll                                   8,853                     9,300          (4.8)%
Repairs and maintenance                              14,748                    11,026          33.8%
Utilities                                            10,553                     9,481          11.3%
Advertising and selling expense                       6,483                     7,659         (15.4)%
Other direct property costs                          12,671                    12,877          (1.6)%
Allocated overhead                                   11,796                    11,857          (0.5)%
Total cost of operations (a)                        139,529                   134,205           4.0%
Net operating income (b)                            301,093                   285,104           5.6%
Depreciation and amortization
expense                                             (79,158)                  (79,742)         (0.7)%
Net income                             $            221,935      $            205,362           8.1%

Gross margin (before depreciation
amortization)                                         68.3%                     68.0%           0.4%
Weighted average for the period:
Square foot occupancy (c)                             92.6%                     91.9%           0.8%
Realized annual rental income per:
Occupied square foot (d)               $              14.41      $              13.81           4.3%
Available square foot ("REVPAF") (d)   $              13.34      $              12.70           5.0%
Weighted average at March 31:
Square foot occupancy                                 93.2%                     92.3%           1.0%
Annual contract rent per occupied
square foot (e)                        $              15.01      $              14.41           4.2%

(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 months ended March 31, 2014 and 2013.

(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 5.1% in the three months ended March 31, 2014 as compared to the same period in 2013 due to a 0.8% increase in average occupancy and a 4.3% increase in realized rent per occupied square foot. The increase in realized rent per occupied square foot 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, increased move-in rates.

Same Store average occupancy increased from 91.9% in the three months ended March 31, 2013 to 92.6% in the three months ended March 31, 2014, representing an increase of 0.8%. We expect the year-over-year occupancy spread to continue to narrow during the remainder of 2014, due to more difficult comparisons.

. . .

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