Public Storage (PSA) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. I will be your conference operator today. At this time. I would like to welcome everyone to the Public Storage second quarter 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you. It is now my pleasure to turn the floor over to your host, Clem Teng, Vice President of Investor Services. Sir, you may begin your conference.

Good morning and thank you for joining us for our second quarter earnings call. Here with me today are Ron Havner, CEO; and John Reyes, our CFO. We will follow the usual format followed by a question-and-answer period. However, to allow for equal participation, we request that you ask only one question when your turn comes up and then return to the queue for any follow-up questions. Before we begin I will provide the forward-looking statement warning. All statements other than statements of historical fact are forward-looking statements. All forward-looking statements speak only as of the date of this conference call and Public Storage undertakes no obligation to update or revise any forward-looking statements except as required by law. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond Public Storage's control that could cause actual results to differ materially in those set forth in or implied by such forward-looking statement.

In addition to the risks and uncertainties of ordinary business operations, the forward-looking statements that Public Storage made on this conference call are also subject to, among other factors, the effect of general and local economic and real estate conditions, risks related to acquisitions, and the risk associated with international operations. Additional information about risk and uncertainties that could adversely affect Public Storage's forward-looking statements are described in the Company's reports filed with the Securities and Exchange Commission, including our 2006 annual report on Form 10-K, our current reports on Form 8-K, and our other SEC filings. We will also provide certain non-GAAP financial measures. A reconciliation to GAAP of these non-GAAP financial measures is included in our press release, which can be found on our website at www.publicstorage.com. As a reminder, our press release and a webcast replay of this conference call are available on our website. Now I'll turn it over to John Reyes.

Thank you, Clem. For the quarter we reported net income of $0.08 per share as compared to net income of $0.55 for the same period last year. Our funds from operations increased to $1.10 per share for the quarter versus $0.99 for the same period last year, an increase of 11%.

The current quarter operating results were impacted by several noncore items, which included costs related to the withdrawn European IPO of $9.6 million, costs associated with reorganizing into a Maryland Trust of $2 million, additional costs related to the Shurgard merger of $1.3 million, and a foreign exchange gain of $5.6 million. In addition, further affecting our net income per share, but not our FFO per share was the amortization of intangible assets that we acquired in the Shurgard merger. Amortization expense totaled $71 million for the quarter, reducing our net income by $0.42 per common share. We expect to record additional amortization expense of $52 million and $37 million for the third and fourth quarters of 2007, respectively.

After adjusting for noncore items in both periods, FFO per share was $1.15 as compared to $1.01 last year, an increase of 14%. This increase was primarily driven by increases in our self-storage operation, including contributions from the Shurgard facilities which added $0.07 of growth, improvements in our ancillary operations added $0.04 and the benefit from less dilution from excess cash balances and refinancing higher rate preferred securities added $0.03.

With respect to our same-store facilities, revenue growth moderated to 1.7% for the second quarter. This increase was due to a 2.4% increase in rental rates, partially offset by a reduction in occupancies. This modest growth in revenues is due in part to our strategy to quickly grow the occupancy levels of the acquired Shurgard facilities. As we've discussed on past calls, rapidly expanding our occupancies at the Shurgard facilities put downward pressure on the occupancies of our same-store portfolio. To mitigate this pressure, we had to reduce rental rates. In fact, during the fourth quarter of 2006, and the first quarter of this year, our market rates were less than the prior year.

During the second quarter this year, as occupancies throughout our portfolio improved, we were able to increase market rates to levels that are now above last year. Furthermore, with the improvement in market rates, we are again seeing healthy mark to market spreads notwithstanding the seasonality of our rental rates. Operating expenses for the same stores rose by 2.1%, primarily from higher property taxes and advertising expenses that were partially offset by lower property insurance and payroll costs. Media advertising expenses increased by approximately $2.5 million in the quarter due to aggressive promotional efforts associated with filling up the entire portfolio.

Property insurance was lower as we benefited from a softer insurance market, payroll was lower due to improved staffing levels combined with an absence of extra staff in anticipation of the Shurgard merger that we experienced last year. Overall net operating income for our same stores increased by 1.5% and our operating margins remain stable at 66%.

With respect to the Shurgard domestic same-store properties, revenues increased by 3.4%. This increase was driven by higher occupancies that averaged 89.4% compared to 84.6 a year ago, partially offset by lower rental rates. Similar to our same-store portfolio, rental rates for the Shurgard same stores were reduced to stimulate rental activity and accelerate occupancy growth. During the second quarter, we were able to increase market rates in this portfolio to those rates experienced by our existing same stores.

Operating expenses for the Shurgard domestic same stores declined by 4.6%. This decline was due to lower payroll costs offset by higher property taxes and advertising expenses. Net operating income for these properties rose by 8% and operating margins improved to 66.2% from 63.4% last year. Our general and administrative expenses increased to $21.5 million for the quarter compared to $7 million for the same period last year. Included in G&A are one-time items associated with our proposed European share offering of $9.6 million, costs associated with respect to reorganizing into a Maryland Trust of $2 million, and costs related to the Shurgard merger of $1.3 million.

In the second quarter of last year, we also had incurred merger related costs of $1.1 million. We do not expect to incur many additional costs for the remainder of 2007, with respect to merger costs. For the second half of 2007 we expect our G&A will be approximately 20 million to $25 million. In July we issued approximately 170 million of preferred securities with an annual rate of 7%. A portion of the net proceeds have been used to repay borrowings on our credit facility. In the third quarter of 2007, we can call for redemption of our 7.5% Series V preferred stock totaling 173 million. EITF D42 charges associated with this redemption would be about $6 million. A decision has not been made to redeem the security.

For the second quarter, distributions paid to our common shareholders were approximately 52% of our funds available for distribution. As a result, retained cash flow was $77 million for the second quarter and $164 million for the first six months of 2007.

During the second quarter, we were unable to execute the share offering for Shurgard Europe. In hindsight, it looks like we caught the beginning of a major shift in capital markets. We still believe a public entity is the best structure for Shurgard Europe's long-term growth, but current market conditions preclude steps in that direction for now. On the flip side, the current market conditions here in the U.S. may present us with increased opportunities to deploy capital at attractive rates of return. Fortunately, we have been aggressive in refinancing the debt we assumed in the Shurgard merger with preferred stock, which has no covenants or maturity. Our current weighted average coupon is under 7%. With our strong credit ratings and significantly retained cash flow, we believe we are prepared for any opportunity. With that I'll now turn it over to Ron.

Thank you, John. We executed well against our plan to drive occupancy in the acquired Shurgard properties and improve pricing across the portfolio. In short we had what I would call a four nine quarter. Occupancy for the Shurgard same-store properties ended the second quarter at 90.4% in the U.S. and 91.1% in Europe, both records. The Public Storage same store's occupancy ended at 92.2% and our overall domestic portfolio ended at 90.6%. Our portfolio had excellent absorption across multiple markets.

Our operating, marketing, and pricing groups combined efforts have been able to overcome whatever adverse impact the turbulence in the housing markets may be having on our business. In fact, our weakest markets are in Florida, due principally to the absence of hurricanes. Florida adversely affected the entire Public Storage same-store portfolio by about 30 basis points in occupancy. The overall domestic portfolio generated annualized revenues of about $1.6 billion during the quarter with an average occupancy of 89.7%. This is up from an average of 87.5% for the first quarter of 2007 and equates to approximately 34,000 net move-ins for the quarter.

Looking ahead into the third quarter, we expect the revenue growth for the Public Storage same-store properties will again be modest. This is due to a greater amount of promotional discounting and marketing to sustain high occupancies as we move out of the rental season. We are also comparing to modest discounting in 2006, as well as very strong Florida markets. However, we believe the Shurgard same-store revenue growth should begin to accelerate in the third quarter due to significantly higher occupancies and rental rates.

We should begin to see better comparisons in the fourth quarter. Revenue growth across the entire domestic portfolio should begin to accelerate, as we start reducing rates and aggressively advertising in October of 2006 in order to drive volume for the Shurgard properties. In addition, as John explained earlier, we will also benefit from better pricing, higher occupancies, and an increase in the spread between market and in place rents. Expense growth should also moderate due to comparable media spend in both periods.

During the second quarter, we focused our media programs on 25 markets and national cable versus 10 markets and no national cable last year. Going into the third quarter, we plan to focus our media programs on 14 markets versus seven last year. As a result, the media spend is expected to be more than double year-ago levels.

The personnel turnover that we experienced earlier in the year with the Shurgard field staff has moderated to normalized levels. As a result, we are achieving better labor efficiency, which should continue to benefit us for the balance of the year. During the quarter, we continue to expand our domestic portfolio. We acquired one facility in California that added 53,000 square feet and we've also entered into agreements to acquire five facilities located in Georgia and California that will add approximately 400,000 square feet.

Now moving to our European operations. The European same-store properties continue to post above average growth. Revenue increased by 10% and net operating income was up by 26%. With occupancies stabilized above 90%, we are achieving higher rental rates, similar to the U.S. Asking rates are nicely above in place rents. The properties also benefited from excellent expense control, resulted in negative expense growth for the quarter that helped drive operating margins close to 60%. We expected the European same-store properties will continue to achieve above average NOI growth due to excellent top line growth, attributable to higher year-over-year occupancies, better pricing, and an improved cost structure.

Our European joint venture portfolio has been filling up nicely. Occupancy at June 30, was 77%. The joint venture's net FFO after interest expense was close to break even during the quarter. Up to this point, the joint venture has been generating losses due to the fill-up and interest expense. We anticipate this will be a source of growth going forward as these properties achieve stabilization.

During the quarter, we expanded the European portfolio with the completion of our development facility in Denmark that added 50,000 square feet. At June 30, we had seven facilities under construction in the joint venture, consisting of 358,000 square feet with a cost of about $75 million. We also have eight facilities under development outside the joint venture, consisting of about 407,000 square feet.

In summary the Shurgard merger integration is complete. Stabilized occupancies in excess of 90% have been achieved across all portfolios and pricing power restored. The economic benefits of the merger should become increasingly clearer as the balance of the year unfolds. We are well positioned for current market conditions. With that, operator, let's open it up for questions.

(OPERATOR INSTRUCTIONS) Your first question is coming from Jonathan Litt of Citi.

It's Craig Melcher here with John. Can you talk about the promotional activities you're during currently versus what you were doing three months ago in terms of specials -- $1 move-in specials?

Craig, this is John. We're still doing a lot of $1 specials, because we -- one, we're on TV quite a bit still right now; two, we're still trying to stabilized the occupancy, although the occupancies are above 90%. We want to make sure that they're stabilized because a lot of that 90% was built over past couple months, so generally people tend to move out quicker during the first couple of months of their stay. So we want to continue to hammer home the move-ins and maintain some more stabilized occupancy before we really start moving forward with some rate -- pushing rates into the portfolio.

Thank you.

Thank you. Your next question is coming from Christine McElroy of Banc of America.

Hi. Good afternoon, guys. As you look forward towards the latter part of the year, are you at all concerned, especially in some of the weaker housing markets, about an upswing in ARM resets and the potential impact on discretionary spending? Does that impact how you're looking at potential performance in these markets?

The short answer is no. Christy, I only touched on housing because it continues to come up. Basically whatever impact we think it's having, our operational people, our marketing, and pricing programs we think are able to work through that as we had pretty good net positive absorption across the portfolio. If you think about though, what really drives our business, it's activity, so if people are moving into a house, that's good and it causes activity, and if people have to move out of a house, people have to -- generally need space. So activity is a positive thing for us, either in or out.

Thank you.

Thank you. Your next question is coming from Christopher Pike of Merrill Lynch.

Good morning. Just a quick question on G&A. I think you guys had guided us to about $11 million per quarter for the full year or for the remaining three quarters last time we spoke. Yet if I look at the second quarter's print and then I back out all the one-timers, it really gets down to about $8.8, but you're still guiding to about $11.5 at the midpoint. John, what is driving the modest uptick from the core G&A run rate in Q2 to drive it to an increase in the second half? Thanks.

There are various things that do that. This is our best guess at what we think it will be for the remainder of the year. I don't want to point to any one specific thing, because I don't think I can at this point in time. What we're doing is we're giving you a best guess at this point in time.

Okay, thanks.

Thank you. Your next question is coming from Lou Taylor of Deutsche Bank.

Thanks, good morning. Ron, can you talk a little bit about your plans to hold the occupancy gains and the pricing gains as you get into the fourth quarter. Are you going to spend more on media, less on media? What's your strategy there?

Well, when you look at Q3, we had a fairly light media last year that was a function of, A, we were pretty full and had a pretty strong Florida market last year. Which is not as strong, we're on media in Florida in Q2 we'll be on in Q3 as well. We did not do a lot of advertising last August because of the pending merger, so year over year we're going to be doing a lot more media this Q3 versus last Q3. As John touched on, we want to sustain these nice occupancy levels, as the rental season abates, we move out of the peak rental season and we want to sustain the pricing power, the pricing flexibility that we've achieved in portfolio. So we're going to keep up with the media, keep up with the promotional discounting to sustain both occupancies and recently good pricing.

Thank you. Your next question is coming from Jay Habermann of Goldman Sachs.

Hey, guys. Good morning. I guess, Ron, your comments about the acquisition opportunities. I'm just curious what sort of trends you might be seeing thus far in terms of the cap rates and are you seeing the buyers change a bit with perhaps the levered buyers sitting on the sidelines?

The changes in the capital markets have come about in 60 days or so, so I don't want to speculate that there's been a huge shift at the single property level. I think people could still get traditional financing 60/60/5% with good cash flow coverage, they may pay a little more, but that financing as best I can tell and in talking to the banks, that financing is available. What's probably more challenging and we're hearing is construction financing or highly levered financing above 80, 85%. So that's going to take certainly a group of buyers or competition for us out of the marketplace that has been making it a little challenging for the last couple years. Those people that have loans on those properties that have those high LTVs as well may be people that are interested in selling the loans as well. So we see -- the phone's ringing a little more and we see the potential for increased activity, possibly, going into the third and fourth quarters.

Thank you.

Thank you. Your next question is coming from Michael Mueller of JPMorgan.

Hi. Can we go back to the G&A question, maybe attack it a different way. The 20 to $25 million for the second half of the year, if we look in the press release now, you kind of take us from the 115 number back down to the 110. You have a lot of what you consider to be nonrecurring items. Out of that 20 to $25 million second half amount, how would you split that between more of the recurring versus the nonrecurring? Because it looks like the recurring level in the first quarter was about 9 million?

Let me see if I can tackle the answer in a different way.

Okay.

Our estimate for the remainder of the year is 20 to $25 million. However, if you split that between the two quarters, I guess I would split it up most equally.

Okay. But if we're not talking about the timing in Q3 to Q4, in Q1 you had a bunch of nonrecurring items. How much of that 20 to $25 million would fall into those buckets where they're considered to be nonrecurring versus stuff that would be recurring?

Hey, Mike.

Yes.

It's 20 to $25 million.

Thank you. Your next question is coming from Michael Knott of Green Street Advisors.

Hey, Ron, just curious if you can comment on your perspective on share buybacks given that you traded at a discount NAV?

Mike, we're in a good spot, we have a lot of financial flexibility and liquidity, and share buybacks are something that we think about certainly more often today and it's really a question of what is our net marginal cost of capital vis-a-vis where's the best place to put it in terms of the highest return. Is it in share buybacks or is it other potential opportunities that we may be seeing in the marketplace, but it is certainly talked about and thought about here a fair amount.

Thanks.

Thank you. Your next question is coming from Paul Adornato of BMO Capital Markets.

I was wondering if you could talk about the impact from the Pods product, which seems to be aggressively advertising on TV as well.

Paul, as best I know, and actually from what I've heard lately, Pods TV advertising this year is either comparable or slightly below last year's. Pods has been advertising on national cable for several years, so whatever impact it's been having, it's kind of been in the numbers -- or whatever impact it's had has been there for a couple of years. So we're not seeing any change in that and that business is fairly highly moving dependent, so they face somewhat different challenges than we do. But there's nothing specific that we can delineate directly related to pods?

Thank you. We have a follow up question coming from Christopher Pike of Merrill Lynch.

How you doing, Ron? I understand your decision to pull the Shurgard deal and the need to find public capital for that entity, however, in the near-term given that this location you guys have witnessed first hand, have you given thought to expanding your presence over there through another public entity or conversely maybe even folding Shurgard into another Public Storage Company in Europe? Would that make sense for you guys?

Well, Chris, if we were -- I really couldn't discuss that and I think what we tried to do earlier in the year was, is the best long-term solution for Shurgard Europe and raising money and having euro denominated currency funding, euro denominated assets is best for Shurgard Europe and it will be best for us in the long run. Having said that, we're always open to alternatives. We know the folks at the public firms over there work with alternatives, but their stock price has moved down, just like the rest of the real estate stocks as well. So I'm sure that's a factor in whatever they would be thinking.

Okay. Thanks a lot, Ron.

Thank you. Your next question is coming from David Harris of Lehman Brothers.

Yes. Good morning, Ron. Actually, associated with that European question, the U.K. property prices generically seem to be under real severe pressure, I'm talking the physical asset as well as the stocks, are you seeing any sign of price depreciation there?

Well, we don't have our London properties on the market and in terms of our operations in London, they're doing quite well, as is all of the European continent. But in terms of -- we don't have the properties on the market, so I couldn't tell you what is happening in terms of the resale market over there in London. Most of Europe, from an acquisition standpoint, is not real efficient in terms of pricing because it's not as liquid, it's not as vibrant as here in the U.S. and a lot of the larger players over in Europe tend to do developments vis-a-vis acquisitions.

Your next question is a follow-up question coming from Lou Taylor of Deutsche Bank.

On the Europe topic. John, if you were to do something in Europe and ultimately take that private six or nine months from now, would the 2Q charges that you expensed, would they be reversed and somehow attributed to that transaction?

Lou, I think you meant take it public as opposed to private. The 9.6 million -- your question, if I understand it right, would be if some of that would be still good going forward? I think that a lot of that -- I shouldn't say a lot of that. A good chunk of that money that was spent is still stuff, so to speak that we can utilize if in fact we are able to revisit the public markets again in the near future. So do we -- would we reverse it, no. It stays as an expense, but it's not necessarily all gone so to speak. Did that answer your question?

Whether it was the potential for a reversal of the expense?

No, it would not be--.

If it went public nine months from now?

No, that would not happen.

From an accounting standpoint, even stuff like the prospectus, the regulatory piece that we may not have to pay again, we can't reverse the charges that we've expensed this quarter.

Okay, great.

Thank you. Your next question is also a follow-up question coming from Michael Knott of Green Street Advisor.

Hey, guys, what's your appetite for additional consolidation activity given some of the discounts that are out there, particularly in the public market and do you have the capacity to expand your platform in such a way again -- such a short time after Shurgard?

Well, we have significant financial flexibility. As John touched on, we're retaining about 75, $80 million a quarter. We've retired, went over 1 billion, $1.5 billion of the Shurgard debt that we took on at the Shurgard merger. If you do the fixed charge coverage ratio, which tells you how much preferred capacity we have, it's close to or rapidly approaching $1 billion here. So we have quite a bit of financial flexibility here inside the organization. We always look at opportunities. From a merger integration standpoint, as I touched on in my comments, Michael, the merger integration, I think both internally and what you are starting to see in the numbers with the 90% occupancy, the merger is pretty well behind us. We've established the Shurgard properties at 90% plus. Personnel turnover is down. So we've gone back to a more more stabilized platform here inside of Public Storage. So we're ready for opportunities.

Thanks.

Thank you. (OPERATOR INSTRUCTIONS) Your next is coming from Thayne Needles of Baird.

A follow-up on the buyback. Is the existing capacity under the authorization a little less than 3 million shares? And if that's right, do you have plans to request an increase in that?

Well, if we were to request an increase, we would first want to use up whatever's authorized, and I think that's just short of 3 million, 2.5 million shares, something like that. So we would use that before we would request an increase in the authorization.

Thank you. Your next question is a follow-up question coming from Christopher Pike of Merrill Lynch.

Hey, John. I just have one last question here. Can you help us understand and quantify how much revenue not in the 2Q run rate due to concessions or specials that you accrued in the second quarter, but will be booked in the third quarter if the occupancy sticks? In other words, what level of free rent associated with lease that you signed in June, when I believe you really pushed occupancy higher, what type of revenue numbers should we expect to fall to the bottom line right out of the box starting July 1 into Q3?

If I understand your question, you're asking about discounts that were given and how much of that may have fallen to Q3?

Yes, that's really not recognized from a cash P&L in Q2?

For the most part, recognize the discounts up-front. That's primarily because we don't have free rent, so to speak, like people who sign long-term leases. Our leases are month to month. And given the churn ratios, we basically take most of it -- the bulk of the discount in the month that the tenant moves in, for the most part. So it's not -- in the first month that they move in, so if someone moves in on the 15, half of it would be in one month and the other half would be in the next month, but it's all gone within the first 30 days of their stay. I would say this, Chris. I'm not going to quantify it for you, but I would say that the numbers are fairly comparable to how they fell last year, so the path that you're going down, I don't think, is really going to be a factor, if you think it's going to be a positive or negative factor.

I was just thinking on a sequential basis, it's money that you didn't have -- it's cash that you didn't have in Q2 that you're going to book in Q3. I'm not really concerned about year over year, I'm basically saying, hey, you booked 116 core in Q2, there's got to be a slug of cash that you basically gave away through a concession in June that's going to hit the run rate in Q3 by doing nothing, by just showing up to work.

That would be true, Chris, but if you're continuing to advertise and drive a higher level -- try to drive a higher level of customer volume, you're going to continue to discount until you get to that stabilized customer base.

Okay. Thanks a lot, guys.

Thank you. Your next question is a follow-up coming from Lou Taylor of Deutsche Bank.

Thanks. John, just going back to your first second, you've had, now that your European portfolio looks like it's going to be on balance sheet for the foreseeable future, what have you got planned for hedging? Are we going to see more in terms of currency fluctuations in your numbers or hedging costs, or what's the outlook over the next six to nine months and in terms of your strategy?

There are some derivatives embedded in the joint ventures with respect to the lungs that they have. So in terms of U.S. dollars, there's 126 million of debt outstanding. We own 20% of that, of the joint venture. Those loans have derivatives to hedge against currency risk, fluctuations, because they do operate in various countries in Europe, as well as interest rate fluctuations. From our perspective, here in the U.S., Public Storage, we are not hedging anything. We don't expect to hedge anything with respect to the FX changes that go on. Our primary reasons for that is we can't guess which way the exchange is going to go. So we'll just -- we'll write it up on the up or the down. That's what we've been doing and what we continue to do.

Thank you. Your next question is coming from Jonathan Litt of Citi.

If you were to do a preferred stock offering today in the market, what do you think the rate you could achieve is relative to the one you did last month?

Interesting you ask the question. I answered that question just this morning. The response I got back was probably something in the neighborhood of about a 7.5% coupon.

Thank you.

Thank you. I would now like to turn the call back over to Mr. Teng for any closing remarks.

I would like to thank everybody for attending our second quarter conference call and look forward to talking to you next quarter. Bye.

Thank you. This concludes today's teleconference. You may now disconnect your lines at this time and have a wonderful day.