Public Storage (PSA) 2007 Q3 法說會逐字稿

Good afternoon. My name is Melissa and I'll be your conference operator today. At this time I'd like to welcome everyone to the Public Storage third 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 period. (OPERATOR INSTRUCTIONS)

It is now my pleasure to turn the phone over to your host, Clem Teng. Sir, you may begin your conference.

Good morning and thank you for joining us for our third quarter earnings call. Here with me today are Ron Havner, CEO, and John Reyes, CFO. We will follow the usual format followed by a question-and-answer period. However, to allow for equal participation we ask 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 get started I want to remind you that all statements other than statements of historical facts included in this conference call are forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control, that could cause actual results to differ materially from those projected in these statements. In addition to the risk and uncertainties of ordinary business operations these forward-looking statements are subject to, among other factors, the effect of general and local and real estate conditions, risks related to acquisitions, and risks associated with international operations.

These and other factors that could adversely affect our business and future results are described in today's earnings press release as well as in reports filed by Public Storage with the Securities and Exchange Commission, including our 2006 annual report on Form 10-Q and subsequent reports on Form 10-Q and Form 8-K. Also (inaudible) these statements speak as of today November 9, 2007. We undertake no obligation up to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. During today's call we will also provide certain non-GAAP financial measures. The reconciliation to GAAP for these non-GAAP financial measures was included in our earnings press release. You can find our press release, SEC reports and our audio webcast replay of this conference call on our website at www.publicstorage.com.

I'll turn it over to John Reyes.

Thank you, Clem. For the third quarter we reported funds from operations of $1.43 per share versus $0.77 last year. As indicated in our press release there were several noncore items that impacted the numbers for both quarters. Notable for the current quarter was the recognition of a large foreign currency exchange gain which increased our funds from operations by approximately $30.4 million or $0.18 per share. We are various intercompany loans between Public Storage and our European subsidiary which totaled 389 million Euros or $556 million as of September 30th. Some of these loans were preexisting at the time of the Shurgard merger, but the bulk of the loans were funded at the beginning of this year to prepay debt totaling 325 million Euros. In order to keep the currency revs here in the U.S. and not in Shurgard Europe we denominated the loans in Euros.

Further we have not hedged our exposure to the fluctuation in exchange rates. During the third quarter the Euro rose by 6% relative to the dollar resulting in a currency exchange gain. We had similar gains totally $10 million in the first half of 2007. Our European business is expected to refinance this debt in the next 12 to 24 months at which time any gain will be realized based upon the exchange rate then in effect. After adjusting for all noncore items in each period our FFO per share was $1.27 versus $1.12 in 2006 representing an increase of 13.4%. Driving this growth are improvements in our domestic same stores, our European same stores, our non-established properties and our ancillary businesses.

With respect to our same stores, revenue growth moderated to 1.7% for the third quarter. This increase was due to a 2.7% increase in rental rates partially offset by a reduction in occupancies. The modest growth in revenue stems in part from aggressive pricing and promotional programs to accelerate net customer move in and improve overall portfolio occupancy. Operating expenses for the same stores roses by 1.5% primarily from higher property taxes and advertising expenses that were partially offset by lower property insurance and payroll costs. Advertising expenses increased approximately $1.8 million as a result of our continued promotional programs. Property insurance was lower, as we benefited from a softer insurance market due to the absence of hurricane activities. Payroll declined because of improved labor management and an absence of extra staff in anticipation of the Shurgard merger last year. Net operating income for our same stores increased by 1.8% and our operating margin remains stable at 68%.

With respect to the Shurgard same stores revenues increased by 6.3% in the third quarter compared to the same period last year. This increase was primarily driven by higher occupancies that averaged 89.4% compared to 84.8% a year ago. The Shurgard same stores also benefited from our ability to raise rates as occupancy levels improved. As with the Public Storage same stores we are seeing improved mark-to-market spreads that position us well for future revenue growth. Operating expenses for the Shurgard same stores decreased by 7.9%. This decline was due to significantly lower payroll costs associated with wage rate roll-down in connection with our new field compensation plans. Net operating margin for these properties roses by 14.4% and operating margins improved to 68.5%.

Our general and administrative expenses declined to $11.4 million for the quarter compared with $36.2 million for the same period last year. Included in G&A were $1.3 million in costs associated with expenses of cancelled development projects. In the third quarter of last year we had incurred a total of $29.6 million in costs associated with the Shurgard merger, including fees to terminate certain contracts and the expensing of cancelled development projects. From a balance sheet perspective we continue to be in a solid position. Debt represented $1 billion, or only 5% of our total capitalization, and preferred securities totaled $3.8 billion, or 21% of total capitalization. Our capital commitments over the next 12 months are estimated to be approximately $320 million, principally to fund our development activities and debt amortization. We currently have $170 million of cash in the bank.

In addition we are retaining a significant amount of our operating cash flow. For the third quarter distributions paid to our common shareholders were approximately 44% of our funds available for distribution. Retained cash flow was $107 million for the third quarter alone and $271 million for the first nine months of 2007. Finally as a reminder, we are in a seasonal business and experience net move outs, lower occupancy and lower marginal rental rates in the fourth quarter. Our third quarter is our seasonally peak. Please keep this in mind, especially for those of you who are forecasting our earnings for the fourth quarter using a sequential methodology.

Before I turn it over to Ron I'd like you all to know today is a very special day for Ron. Ron gets to add another candle to the birthday cake today, bringing the total to 50. So please join me in telling Ron happy birthday.

Thank you, John. Thank you, John. We're in a challenging operating environment, whether due to housing, recession, increased supplies, or competitors trying to adopt our pricing strategies. Regardless we continue to do reasonably well and are gearing up for a dynamic 2008. Before I get into the trends we are seeing let me give you the overall picture of our sources of earnings. Consolidated funds from operations, before minority interest, preferred dividends, interest income and G&A -- what I would consider operating earnings -- was about $315 million for the quarter. With that about $160 million, or half, came from the Public Storage same stores, $47 million, or about 15% came from the Shurgard same stores, and $21 million or 7% came from the European same stores. Another $60 million, or about 20% came from our non-same-store properties, both in the U.S. and in Europe. The balance is from our commercial properties, including our investment in PS Business Parks and our ancillary businesses.

And while our Public Storage same stores are certainly the best indicator of organic growth in the business, they are much less a determinant of our growth rate than they were two years ago. For overall our domestic portfolio occupancy ended the third quarter at 88.2%, 40 basis points higher than last year. In-place rents were also higher by 2.7% and NOI improved by 6.8%. So we have higher occupancies and higher rents than a year ago and we are in rent roll-up. Promotional discounts have been higher this year versus last year but will be more comparable in the fourth quarter and going into the 2008. On the domestic front it is really a tale of two cities between the Public Storage same stores and the Shurgard same stores.

For the Public Storage same stores revenue growth is moderate at 1.7%, the same as the second quarter. Our revenue growth has been trending down since the merger last year but I think we may be bottoming out. We may see some acceleration of revenue growth in the quarters ahead due to easier comparisons and better overall pricing. However, we are in a challenging operating environment and it may be awhile before we get back to 5%-plus top-line growth. Operating expense growth was held in check, primarily from lower payroll costs. We expect this benefit will continue into the fourth quarter but will be less favorable in 2008. Advertising costs should be more favorable in the fourth quarter and into 2008, as our spending is expected to be more comparable period to period versus the significant increase in advertising in 2007 versus 2006.

It is a different story for the Shurgard same stores. For the quarter revenue growth accelerated to 6.3% primarily from higher occupancy. This is the highest growth rate since completing the merger and almost doubled the growth rate of 3.3% from the first quarter of 2007. Operating expenses continue to decline primarily from lower payroll costs. For the fourth quarter we expect relatively strong revenue growth due to higher year-over-year occupancies and rates. Operating expenses should continue to decline but not at the levels just experienced. For 2008 we anticipate that the period-over-period occupancy and revenue growth will moderate and operating expenses will be more comparable to the Public Storage properties.

In Europe our management team simply shot the lights out. The organizational and operational changes we affected last year and the relentless focus on cost and sales resulted in another exceptional quarter. Same-store revenues increased by 10% and net operating income grew by 27%. Similar to the U.S. with occupancy stabilized about 90%, market rates have been increased further, improving the spreads between in-place and market rents. The properties also benefited from excellent expense control resulting in negative expense growth through the quarter that drove operating margins of just over 63%, a record high. For the fourth quarter we expect that European same stores will continue to post above average NOI growth due to higher year-over-year occupancies, better pricing and an improved cost structure along, with the benefits from centralized marketing and pricing. For 2008 we expect that NOI will be stronger due to the large spread between asking and in-place rents and continued cost controls.

Last let me touch on capital allocation opportunities. During the month leading up to the recent changes in the capital markets, the use of cheap aggressive debt instruments was artificially impacting the markets for storage facilities. During the first six months of this year Public Storage selectively acquired five properties while we and many of the more traditional buyers watched deals close at prices we did not understand. The changes in the capital markets have significantly impacted how transitions are financed and the prices that buyers are now willing to pay. Highly-leveraged financing based on forward-looking lease-ups and stabilized income projections is now scarce. Artificial valuations are being corrected and sellers are either out of the market and repricing FFOs based on NOI growth and replacement cost. In addition, quality properties in high-barrier markets still command premiums, while there is a dirth of activity in secondary the markets and [fee] properties. We will continue to monitor the markets for opportunities to deploy capital and will remain disciplined in our capital allocations.

With that, operator, let's open it up for questions.

(OPERATOR INSTRUCTIONS) Your first question is coming from Jonathan Litt with Citigroup. Please go ahead.

Hi, it's Craig Melcher here with Jon. Just wanted to get an update on your plan -- longer-term plans for Europe. Are you still -- is an IPO still what your longer term goal is there or have you revisited that given the strength you've been experiencing?

Craig, this is John. Long term we still believe that an IPO for Shurgard is the best course of action to position the Company for much accelerated growth going into the future. Right now, as you know, the capital markets in Europe are just as bad, if not worse than they are here in the U.S., so trying to do an IPO in this market is certainly just out of the question at this time. So we will sit and wait and continue to enjoy the benefits of the operations of Shurgard Europe.

Thank you. Your next question is coming from Christy McElroy with Banc of America. Please go ahead.

Hi, good morning, guys. Just going back to capital allocation, can you provide some color on your cancelled development projects? Were there any overall macroeconomic trends that caused to you cancel these projects such that you're slowing your development spending at all, or was it more one-off instances, it's not related to any change in strategy?

Yes, Christy, the cancelled development properties I think are about half Europe, half U.S. In Europe it's a couple of properties, one where we've been working on a long time that we ended up losing, another in Paris where we did a fair amount of work and then it's just not feasible to move forward. Paris is very challenging.

In the U.S. they were repackages not ground-up developments and, again, we were going through the entitlement process, rezoning process that we typically have to do for a repackage. Probably spent a little more money than we should have, but got into it and the conditions that the cities were imposing just didn't make the projects economically feasible any more to do the repackage, so we abandoned them. But there's no changes in our strategy or anything like that.

Thank you.

Thank you. Your next question is coming from Lou Taylor with Deutsche Bank. Please go ahead.

Thanks, good morning, and happy birthday, Ron. Ron, can you give a little color on the Shurgard revenue growth in terms of how are retention rates running and how does length of stay compare to maybe markets or properties where you haven't been as promotional?

Well, I have John amplify this since he runs pricing. but the analysis that we've done and all the data that I've seen you could pretty well stack the portfolios on top of each other in terms of customer duration, churn rate, all the typical matrix that one looks at in a portfolio. As you know, when you -- as we've communicated before, when you're a fill-up mode -- and certainly the Shurgard properties we had higher move-ins, higher growth in occupancy during the first three to six months of that -- you have a higher churn rate as you build in the occupancy, so it will be awhile before we really get them stabilized. But on a portfolio basis it looks almost the same as Public Storage.

I don't have anything to add to that. That's exactly right. It's the same operating metrics that we've seen in our legacy properties.

Thank you. Your next question is coming from Mark Biffert from Goldman Sachs. Please go ahead.

Hi, guys. John or Ron, just had a question on your markets, what you're seeing -- where you're seeing the greatest revenue growth and what markets do you continue to discount due to weakness in fundamentals or market trends?

Well, the markets that we are seeing the most strength in our portfolio is basically the Seattle, Portland, the Pacific Northwest. The Midwest is doing very well for us. Some of the our largest markets, such as Los Angeles and San Francisco, are starting to perk up. Where we're struggling the most is in Florida and some of the northeastern markets going up to the D.C. markets, Philadelphia, Baltimore and even Atlanta has been weak for us. I forgot the other part of your question but -- oh, in terms of discounting, bottom line is we discount across the whole country. We just cannot buy property -- it just really depends on the discounting. It depends on occupancy, the way the inventory is moving or not moving we'll discount.

The bottom line is we will continue to do discounting because we believe it works. The dollar special works. We're going to continue to do it. We think the operating results that you see in the Shurgard portfolio bears that out. And also even in Europe, Europe adopted the one Euro special and you can see the results that they have enjoyed over the past couple quarters. So we will continue to discount.

Great, thanks.

Thank you. Your next question is coming from David Cohen with Morgan Stanley. Please go ahead.

Good afternoon. So, Ron, your margins on the Shurgard portfolio now have basically reached PSAs levels. I'm curious do you think you are done with the cost synergies at this point? How much further do you think you can increase them? And just secondly, you previously talked about a revenue enhancement opportunity, as well, from the merger. Are you guys at all working on that as well and what are the prospects so far?

Well, let me -- I'll start with the revenue and then work on the expense side. I think on the revenue enhancement, starting this quarter Shurgard same store is up 6+% and over in Europe up over 10%, so I think that's pretty good revenue enhancement and the outlook is pretty good in that arena. And as John just touched on, both portfolios, we've combined them or introduced in Europe a similar pricing and promotional strategy and I think the results speak for themselves. On the cost side as I touched on, in Q4 you're going to see the continued benefit to the wage rate roll-down in the Shurgard same stores and that will dissipate going into next year. Advertising growth will be more comparable going into '08 versus '07, and I think we've got another quarter or two to flush out the yellow pages. There was $3 million to $5 million in savings in yellow pages and that's got another quarter or two as the phone books roll through to flush through the P&L.

There's a whole bunch of smaller items. We've got management offices to consolidate. That takes awhile and that'll be working through. Obviously, with the high churn in the Shurgard employees post merger our recruiting, hiring costs, we're at an accelerated pace. That has moderated. We down to a little more normalized run rate in terms of hiring. How much that is I don't know, but you should some of those benefits. R&M in the Shurgard portfolios was very high this year; trying to get some properties up to our standards and that should moderate going into next year a little bit as well.

And you've got little things like the phones -- the telephones in the Shurgard properties are about $100, $150 more a month than they run in our properties, so you have to go through and identify the phone lines, delete the phone lines, and that's a year to a year and a half project. So there's little things like that, combined with -- I'm sure there's some things on the expense side that'll go up, such as property taxes and those kinds of things. There's still some more stuff but it's not the big stuff that we identified. You'll see most of that flush through by the end of 2007.

Thank you.

Thank you. Your next question is coming from Chris Pike with Merrill Lynch. Please go ahead.

Good morning. Ron, I guess if I ask you how your birthday's going so far does that count as a question?

How you doing, Chris?

I'm okay. I guess maybe for you or John, back to Lou's question regarding retention, maybe I missed this in the release but can you guys talk about what type of rate-ups -- rental rate-ups you are seeing in those units that you're retaining at these longer durations, they're greater than five or six or seven months, whatever that break-even point from that perspective is when you start to make money. What kind of rental rate-ups are you seeing on the retention side?

Sorry, Chris, Ron and I are looking at each other trying to understand your question.

I guess -- I'm trying to think through. I guess talking to Clem in the past, it's not until some point in time until you burn off the 113 and I'm just wondering, after you get to that sweet spot in that retention period, are you starting to see really significant rental rate-ups in those renewals?

Let me see if I can answer your question if I understand it right. Generally -- we do not raise rents generally to our tenants but once a year. So let's just say I'm a new tenant and I move in, I get the dollar special. We generally will not raise the rent to me or any other tenant until they've been here at least one year. So there isn't, geez, they've been here seven months and we're going to up their rent, so to speak. That doesn't happen generally here. So we do it once a year.

We generally raise our rents to our existing tenants during the period usually commencing in March through June, which we believe is the most opportune time to raise rents for our tenants. We generally do not raise rents to tenants in the fourth quarter because our experience has been very negative when we do that. Chris, I'm not sure that that answers your question.

It does and maybe I will just follow up to get some further clarification off line. Thanks a lot, guys.

Okay.

Thank you. Your next question is coming from Michael Knott with Green Street Advisors. Please go ahead.

Hey, guys. Hey, Ron, I'm wondering if you can just provide a little more color on your comment that it's a challenging operating environment. It seems last quarter it seemed to be the case that the housing market and all that wasn't affecting too much. What changed in the last three months and is it lower occupancy at 9/30 compared to last year? What's coloring that perspective? Thanks.

I don't know, Michael, that my view of the market per se is changed. I will tell you psychologically I always feel better in June and July when we are 91%, 92% occupied than I do in October when we are 89% occupied. But I think my comments are just straight out preempting the question of what is the impact of housing that we typically get each quarter. I -- the 40,000-foot view I believe the economy's slowed; housing, all the changes in the capital markets the last five or six months. And I would believe that it's having some impact on demand for all businesses, including ours. How much, I don't know.

It is hard to delineate between, quote, bad housing markets and good housing markets. I was reading the script of Bobby Toll on the housing markets and how he was grading them and one of the worst markets was Minnesota and we're doing great in Minnesota. So it's a little hard for us to correlate but I'm sure it's having some impact for us in Florida, some impact for us in Vegas, but how much I don't know.

Thanks.

(OPERATOR INSTRUCTIONS) Your next question is coming from Michael Mueller with JPMorgan. Please go ahead.

Hi, a question about Europe's margins. They're still running a lot higher than where they were but still call it about 500 basis points below the U. S. Is there any structural reason why the margins will remain notably lower than the U.S. over time or [do you think they'll gravitate to where you] operate in the U.S.?

Well, all of the things being equal, Mike, there's a plus in Europe and a minus. Our European operations at this time do not have anywhere near the scale in markets that we have in the U.S. I mean, they just don't. And markets such Seattle, Dallas, Houston, LA, where we have huge scale it drives efficiencies in the management, in the yellow pages, in our advertising, just a whole variety of things and then the overall scale of the business in totality. That in Europe, though, is offset by much higher rates. The blended rate in Europe I think rev path for Europe was $24.50 a foot in Q3. That's almost double the rental rate in the rev path in the U.S.

So in markets where your rental rates are much higher typically your margins are much better. And here in the U.S. -- and it's the same in the Europe when you go between Belgium and London -- but here in the U.S. our operating margins in Hawaii are far better than they are in Kansas because in Hawaii the rent's $3 a foot and in Kansas it's $0.50 per foot and you have the fixed costs of payroll and property taxes, et cetera. So higher rent per foot lead to better operating margins. In Europe that's offset by lack of scale and then kind of a base-level higher operating cost structure in terms of personnel and few other things. In the long run will Europe get to 68%? That's a possibility. They actually had scalability, my guess would be they would even have a chance going above the U.S. just because of the higher rental rates.

Okay. Thanks.

Thank you. Your next question is coming from Lou Taylor with Deutsche Bank. Please go ahead.

Thanks. Ron, in terms of the European loan that you've got there, you're giving guidance of repaying 12 to 24 months out. Why wait that long and why wouldn't you do something, say, within the next 12 months?

Lou, this is John. We could do something but the capital markets again are in flux in Europe. This is not an opportune time to be doing that. We will do it when the opportunity is there, but at the current time frame we simply don't have enough visibility as to when we will do that at this time. Certainly, as soon as -- we'd like to -- we want to get our money back -- the money back into the states, but again it's really a capital market driven event.

Thank you.

Thank you. Your next question is coming from Mark Biffert with Goldman Sachs. Please go ahead.

Hi, guys. Related to the $107 million in cash flow that you guys are [throwing off,] I'm just wondering as you look to the future in terms of acquisition bonds -- or doing acquisitions versus maybe doing share repurchases, do you have a preference there?

Mark, we're always evaluated debt opportunity acquisitions versus share repurchases versus development. So we're looking at that all the time and we are in a fortunate position that we have the financial flexibility to pretty much take advantage of whichever opportunity we think is best or several opportunities at the same time. Yes, we're looking at it all the time.

Thanks.

Thank you. Your next question is coming from Michael Knott with Green Street Advisors. Please go ahead.

Hey, guys, does the decision to refinance Europe at some point imply a much longer time until an IPO is completed or does it reflect something you may have learned from the IPO process over the summer that maybe getting paid back from the offering isn't as appealing structurally over there?

No, no, we want those -- [it's easier today,] Michael, the loan from -- to Shurgard, Europe -- let's step back in time. Why did we make the loan? As John said, there was a loan there existing at the time of the merger and then we advanced money into Europe to pay off about 350 million Euros of mortgage debt encumbering the wholly-owned properties. The properties were under leveraged and we wanted to clean up that financing in preparation for the IPO.

In connection with the IPO, the plan was post IPO to go out and refinance that, establish a separate credit facility in Shurgard Europe with European lenders to funds their operation on an ongoing basis. That is still the plan. The thing that's held it up at this juncture is, A., the capital event combined with the banking market in Europe is equally as challenged as it is in the U.S. It's not that we couldn't get financing, it's just we'll probably get better rates and terms if we wait a little bit.

But, Michael, the intercompany loan was not a structural flaw in the IPO, it was not a reason why the IPO was not successful, so we have no reason to believe that continuing to have the intercompany loan would prevent us from doing an IPO if the opportunity arose.

Thank you.

Thank you. Your next question is coming from David Cohen with Morgan Stanley. Please go ahead.

Hey, you guys obviously have the financial flexibility to do acquisitions. I guess my question is, operationally are you far enough along on the Shurgard integration to even do a larger portfolio acquisition at this point in time?

Well, John Graul's sitting here at the other end of the table and he runs operations and he's nodding his head, bring it on. No, as I touched on I think at the end of last quarter and I'll reiterate again hear, we did have a lot of changes in the personnel, both at the regional, the district and property levels. That started really stabilizing in July and August and we are really at kind of a normal run rate. The merger provided us great opportunity to re-examine our whole hiring, recruiting processes and I'm really excited about the people side of it. From a systems standpoint, you'll recall that at the time we did the Shurgard merger, the evening it was approved everything was on to our system so that's never really been an issue, and I think over the last year we've demonstrated our ability to quickly integrate portfolios into our pricing, promotional, internet and media programs as well. So, yes, we're stabilized and on back-to-normal kind of operating basis.

Thanks.

Thank you. There appear to be no further questions. I would like to turn the floor back over to Clem Teng for any closing remarks.

I'd like to thank everybody for participating on the call today. We'll see many of you next week at the [Navy] conference in Las Vegas. If not then we'll talk to you next quarter. Thanks.

Thank you. This concludes today's Public Storage third quarter 2007 earnings conference call. You may now disconnect.