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

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Form 10-Q for PUBLIC STORAGE


5-Aug-2014

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, 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 June 30, 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 six months ended June 30, 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 took advantage of a significant increase in properties being marketed for sale and 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). We believe that the increase in properties marketed for sale was primarily driven by easier access to capital in the current low interest rate environment and improved property valuations. During the six months ended June 30, 2014, we have acquired six self-storage facilities for approximately $37.1 million. On July 1, 2014, we acquired 25 self-storage facilities for approximately $240.0 million, and as of August 4, 2014, we have four additional self-storage facilities under contract for an aggregate purchase price of approximately $40 million. 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 June 30, 2014, we had development and expansion projects which will add approximately 2.1 million net rentable square feet of storage space and will cost approximately $242 million. A total of $61 million in costs were incurred through June 30, 2014 with respect to these projects, with approximately $70 million of the remaining costs expected to be incurred in the last six months of 2014, and the remainder in 2015. 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 June 30, 2014, our capital resources totaled approximately $763 million, consisting of (i) cash and cash equivalents totaling $388 million, (ii) $205 million received from Shurgard Europe in July 2014 in repayment of its shareholder loan to us, and (iii) $170 million of retained operating cash flow for the remainder of 2014. We also have approximately $286 million of available borrowing capacity on our line of credit. 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 six months ending December 31, 2014.

At June 30, 2014, we had estimated remaining 2014 capital commitments totaling approximately $679 million, consisting of $322 million to repay our term loan, $7 million in maturities on notes payable, $280 million in property acquisitions, as well as approximately $70 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.

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 June 30, 2014 and 2013

For the three months ended June 30, 2014, net income allocable to our common shareholders was $218.4 million or $1.26 per diluted common share, compared to $207.7 million or $1.20 per diluted common share for the same period in 2013, representing an increase of $10.7 million or $0.06 per diluted common share. This increase is due primarily to a $38.9 million increase in self-storage net operating income, offset partially by a $15.5 million increase in depreciation and amortization associated with the 127 self-storage facilities acquired since January 2013.

The increase in our self-storage net operating income was the result of a $21.2 million increase for our Same Store Facilities combined with a $17.7 million increase for our non-Same Store Facilities. Revenues for the Same Store Facilities increased 5.3% or $22.6 million in the quarter ended June 30, 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 1.2% or $1.5 million in the quarter ended June 30, 2014 as compared to the same period in 2013, due primarily to increases in property taxes offset partially by lower on-site property manager payroll. The increase in net operating income for the non-Same Store Facilities is due primarily to the impact of the acquisition of 127 self-storage facilities since January 2013.

Operating Results for the Six Months Ended June 30, 2014 and 2013

For the six months ended June 30, 2014, net income allocable to our common shareholders was $392.4 million or $2.27 per diluted common share, compared to $369.6 million or $2.14 per diluted common share for the same period in 2013, representing an increase of $22.8 million or $0.13 per diluted common share. This increase is due primarily to a $69.8 million increase in self-storage net operating income, offset partially by a $33.5 million increase in depreciation and amortization associated with the 127 self-storage facilities acquired since January 2013.

The increase in our self-storage net operating income was the result of a $37.2 million increase for our Same Store Facilities combined with a $32.6 million increase for our non-Same Store Facilities. Revenues for the Same Store Facilities increased 5.2% or $43.9 million in the six months ended June 30, 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 2.6% or $6.8 million in the six months ended June 30, 2014 as compared to the same period in 2013, due primarily to increases in property taxes, snow removal and utilities 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 127 self-storage facilities since January 2013.


Funds from Operations and Core Funds from Operations

Funds from Operations ("FFO") and FFO per share are non-GAAP (generally accepted accounting principles) measures defined by the National Association of Real Estate Investment Trusts and are considered helpful measures of REIT performance by REITs and many REIT analysts. FFO represents net income before real estate depreciation, gains and losses, and impairment charges, which are excluded because they are based upon historical real estate costs and assume that building values diminish ratable over time, while we believe that real estate values fluctuate due to market conditions. FFO and FFO per share are not a substitute for net income or earnings per share. FFO is not a substitute for GAAP net cash flow in evaluating our liquidity or ability to pay dividends, because it excludes financing activities presented on our statements of cash flows. In addition, other REITs may compute these measures differently, so comparisons among REITs may not be helpful.

For the three months ended June 30, 2014, FFO was $1.99 per diluted common share, as compared to $1.83 for the same period in 2013, representing an increase of 8.7%, or $0.16 per diluted common share.

For the six months ended June 30, 2014, FFO was $3.73 per diluted common share, as compared to $3.40 for the same period in 2013, representing an increase of 9.7%, or $0.33 per diluted common share.

The following tables reconcile diluted earnings per share to FFO per share, and sets for the computation of FFO per share:

                                          Three Months Ended June 30,         Six Months Ended June 30,
                                            2014               2013              2014            2013

                                                 (Amounts in thousands, except per share data)
Reconciliation of Diluted Earnings
per Share to FFO per Share:

Diluted Earnings per Share             $         1.26     $         1.20    $        2.27     $     2.14
Eliminate amounts per share excluded
from FFO:
Depreciation and amortization,
including amounts from investments
and excluding amounts allocated to
noncontrolling interests and
restricted share unitholders                     0.74               0.63             1.47           1.26
Gains on sale of real estate
investments, including our equity
share from investments, and other               (0.01)                  -           (0.01)              -
FFO per share                          $         1.99     $         1.83    $        3.73     $     3.40


Computation of FFO per Share:

Net income allocable to common         $                  $                 $                 $
shareholders                                  218,352            207,685          392,404        369,621
Eliminate items excluded from FFO:
Depreciation and amortization                 106,443             90,937          215,464        181,938
Depreciation from unconsolidated
real estate investments                        21,062             18,158           40,733         37,061
Depreciation allocated to
noncontrolling interests and
restricted share unitholders                     (811)              (979)          (1,939)        (1,994)
Gains on sale of real estate
investments, including our equity
share from investments, and other              (1,205)                  -          (1,292)              -
FFO allocable to common shares         $      343,841     $      315,801    $     645,370     $  586,626
Diluted weighted Average common
shares                                        173,181            172,647          172,995        172,580
FFO per share                          $         1.99     $         1.83    $        3.73     $     3.40


We also present "Core FFO per share," a non-GAAP measure that represents FFO per share excluding the impact of (i) foreign currency exchange losses of $1.7 million and $4.0 million for the three and six months ended June 30, 2014, respectively, (a gain of $5.9 million and a loss of $6.8 million for the same periods in 2013), and (ii) other items, comprised primarily of a $7.8 million accrual related to a legal settlement included in ancillary cost of operations for the six months ended June 30, 2014, a $4.1 million reduction in ancillary cost of operations associated with recognition of a deferred tax asset in the three and six months ended June 30, 2014, and our $1.4 million equity share of charges incurred by Shurgard Europe in closing a facility during the six months ended June 30, 2013. We believe Core FFO per share is a helpful measure used by investors and REIT analysts to understand our performance. However, Core FFO per share is not a substitute for net income per share. Because other REITs may not compute Core FFO per share in the same manner as we do, may not use the same terminology, or may not present such a measure, Core FFO per share may not be comparable among REITs.

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

                                             Three Months Ended June 30,          Six Months Ended June 30,
                                                                 Percentage                          Percentage
                                            2014        2013       Change       2014        2013       Change

FFO per share                             $   1.99    $  1.83         8.7%    $   3.73    $  3.40         9.7%
Eliminate the per share impact of
items excluded from Core FFO:
  Foreign currency exchange loss (gain)       0.01      (0.03)                    0.02       0.04
  Other items                                (0.03)          -                    0.03       0.01
Core FFO per share                        $   1.97    $  1.80         9.4%    $   3.78    $  3.45         9.6%


Real Estate Operations

Self-Storage Operations: Our self-storage operations represent 93% of our revenues for the six months ended June 30, 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 June 30,                Six Months Ended June 30,
                                                       Percentage                               Percentage
                             2014            2013        Change        2014          2013         Change

                                                  (Dollar amounts in thousands)
Revenues:
Same Store Facilities   $      452,797    $ 430,179         5.3%    $  893,419    $  849,488         5.2%
Non Same Store
Facilities                      48,006       21,397       124.4%        92,971        41,753       122.7%
Total rental income            500,803      451,576        10.9%       986,390       891,241        10.7%
Cost of operations:
Same Store Facilities          126,785      125,335         1.2%       266,314       259,540         2.6%
Non Same Store
Facilities                      15,642        6,802       130.0%        32,181        13,590       136.8%
Total cost of
operations                     142,427      132,137         7.8%       298,495       273,130         9.3%
Net operating income
(a):
Same Store Facilities          326,012      304,844         6.9%       627,105       589,948         6.3%
Non Same Store
Facilities                      32,364       14,595       121.7%        60,790        28,163       115.9%
Total net operating
income                         358,376      319,439        12.2%       687,895       618,111        11.3%
Total depreciation and amortization expense:
Same Store Facilities          (77,929)     (79,331)       (1.8)%     (157,087)     (159,073)       (1.2)%
Non Same Store
Facilities                     (27,781)     (10,918)      154.5%       (56,956)      (21,478)      165.2%
Total depreciation and
amortization expense          (105,710)     (90,249)       17.1%      (214,043)     (180,551)       18.5%
Total net income        $      252,666    $ 229,190        10.2%    $  473,852    $  437,560         8.3%

Number of facilities at period end:
Same Store Facilities                                                    1,983         1,983             -
Non Same Store
Facilities                                                                 212            85       149.4%
Net rentable square footage at period end (in
thousands):
Same Store Facilities                                                  125,492       125,492             -
Non Same Store
Facilities                                                              15,561         6,667       133.4%

(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 June 30, 2014.

Selected Operating Data
for the Same Store
Facilities (1,983
facilities)
                               Three Months Ended June 30,              Six Months Ended June 30,
                                                     Percentage                               Percentage
                              2014         2013        Change        2014          2013         Change

                                  (Dollar amounts in thousands, except weighted average amounts)
Revenues:
Rental income              $ 431,362    $ 409,340         5.4%    $  849,851    $  807,645         5.2%
Late charges and
administrative fees           21,435       20,839         2.9%        43,568        41,843         4.1%
Total revenues (a)           452,797      430,179         5.3%       893,419       849,488         5.2%

Cost of operations:
Property taxes                46,986       44,972         4.5%        94,588        90,605         4.4%
On-site property manager
payroll                       25,081       26,130        (4.0)%       51,904        52,502        (1.1)%
Supervisory payroll            8,734        8,868        (1.5)%       17,587        18,168        (3.2)%
Repairs and maintenance        9,441        9,281         1.7%        24,189        20,307        19.1%
Utilities                      9,038        8,785         2.9%        19,591        18,266         7.3%
Advertising and selling
expense                        6,047        6,580        (8.1)%       12,530        14,239       (12.0)%
Other direct property
costs                         13,152       12,703         3.5%        25,823        25,580         0.9%
. . .
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