Public Storage (PSA) 2007 Q4 法說會逐字稿

Good afternoon. My name is Jody, and I will be your conference operator today. At this time, I would like to welcome everyone to the Public Storage fourth 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 floor over to your host, Vice President of Investor Relations Clem Teng. Sir, you may begin your conference.

Good morning, and thank you for joining us for our fourth 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 request that you ask only one question when your turn comes up, then returning 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 fact 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 risks and the uncertainties of ordinary business operations, these forward-looking statements are subject to, among other factors, the effect of general and local economic and real estate conditions, risks related to acquisitions and joint ventures, and risks associated with the 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 2007 annual report on Form 10-K, and subsequent reports on Form 10-Q, and Form 8-K. All forward-looking statements speak only as of today, February, 28th, 2008. We undertake no obligation 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. A reconciliation to GAAP of these non-GAAP financial measures is included in our earnings press release. You can find our press release, SEC reports and audio webcast replay of this conference call on our website at www.PublicStorage.com.

Now, I will turn it over to John Reyes.

Thank you, Clem.

For the fourth quarter of 2007, [funds] from operations were $1.40 per common share, compared to $0.89 for the same period last year. There were two significant non-core items that impacted numbers for both quarters. During the fourth quarter of 2007, we recognized a foreign currency exchange gain of approximately $16.6 million that resulted in an increase of $0.10 per share. While in the fourth quarter of 2006, we incurred integration expenses associated with the Shurgard acquisition, totaling $23.5 million, which resulted in a reduction of $0.14 per share. After adjusting for these and other non-core items in each of the periods, our core FFO was $1.30 per share in the fourth quarter of 2007, as compared to $1.08 for the same period in 2006, representing an increase of 20.4%. This growth is primarily driven by improvements in net operating income generated from each of our groups of properties.

For the fourth quarter 2007, operating income for our legacy Public Storage same stores increased by 4.9% as compared to the same period last year. The Shurgard same stores improved by 17%. The European same stores improved by 13.5%, and our non-stabilized group of facilities grew by 22.6%. Overall, this growth was driven by higher occupancies, higher realized rents per occupied square foot, and tight expense controls.

The European market presents with us an excellent opportunity for growth. If the European market were to build self-storage facilities on the same population density as the U.S., there could be a need for approximately 34,000 facilities in Western Europe. With less than 15,000 self-storage facilities currently operating in Western Europe, there's an enormous amount of potential growth. In the city of Paris alone, where there are approximately 60 facilities, the population base could probably support 1200 facilities.

The key for us to take advantage of this growth opportunity is to access the appropriate capital. We believe a public entity with a European-based capital structure is the best and the most efficient long-term structure to realize this potential. We started down this path in the first half of 2007 with a public offering to sell 51% of Shurgard Europe, but terminated the public offering due to adverse capital market conditions. Fortunately, institutional investor interest in partnering with us in Europe is strong, and we are working on a transaction that would accomplish most of the objectives of the public offering. Our plan is to retain a significant equity interest in Shurgard Europe and participate in this huge growth opportunity.

With that, I will turn it over to Ron.

Thank you, John.

2007 was a good year for all of our businesses, and we are well positioned going into 2008. Our combined domestic same-store REVPAF, or revenue per available square foot, was up 2.7% in 2007. Average occupancy was 30 basis points higher and rates increased by 2.3%. We have positive absorption and rate growth in 2007.

We also realized many of the anticipated benefits from the Shurgard accusation in the areas of property payroll, Yellow Pages and overall operating efficiencies. As a result, our combined same store NOI increased by 4.9%, and our gross profit margin improved to 67.4% from 66% in 2006. Our combined same store in-place rents ended the year up by 2.7%. So with higher rates and occupancies at 88%, we are solidly positioned going into 2008.

Our most challenging markets were in Florida, where we saw negative top line growth. Florida makes up approximately 10% of our combined same store domestic portfolio and reduced our overall top line growth by about 50 basis points. Partially offsetting Florida were the Phoenix, Las Vegas, Minneapolis and Denver markets, which all had solid revenue growth. In addition, our two largest markets, Los Angeles and San Francisco, had a respectable year.

Our European same stores continue to perform exceptionally well. Having adopted many of our U.S. best practices, Europe finished the year with top line growth of [90]%. Europe also realized cost savings from standardizing and centralizing certain operating functions that drove NOI higher by 23% for 2007, and the gross profit margin to 60%. Similar to the U.S., Europe's in-place rents for the end of 2007 were higher by nearly 8%. Market rates continued to increase, further widening the spread between asking and in-place rents. With higher rates and occupancies at 89%, our European stores are well positioned.

OUr general and administrative expenses for the fourth quarter of 2007 were more normalized, and represented about 2.2% of revenues. This is much more in line with our historical average, and close to what we would expect going forward. We are going into 2008 with tremendous financial strength. Our fixed charge coverage ratio is about 3.5 times, cash is over $200 million, and retained cash flow is nearly $400 million. We have over $1.5 billion of buying power, an anomaly in the current capital-constrained marketplace. We are open for business and ready to expand our portfolio.

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

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question is coming from Michael Mueller of JP Morgan.

Yes, hi. Question looking at the ancillary income. If we look back either on a year-over-year basis, as well as sequentially, the historical run rate has been called about 20, 21, $22 million a quarter in expenses. This quarter it went down to 15 or 16. Can you talk about what happened in the fourth quarter on that expense line item?

Michael, this is John. It was -- it had to do mostly with our tenant reinsurance business, the expense line in that particular business was down, primarily due to better claims control and tighter expense control within that segment of our business.

Okay. So if we're thinking about that, compared to the rest of the year, does it seem like the fourth quarter on the expense side was more of an anomaly or just something that we should think of going forward?

Well, going forward, it will be really dependent upon the number of claims that come in from tenants, and the dollar amount of such claims. So it's a little difficult for us to -- to project what those numbers might be going forward.

Okay. Thanks.

Thank you. Our next question is coming from David Cohen of Morgan Stanley.

Hey, good afternoon. You talked about -- you know, that you are open for business, you have $1.5 billion in buying capacity. Can you talk about, like, the acquisition market? Are you seeing a lot of distressed sales at this point, and are you looking more for value add or full occupancy assets at this point?

David, this is Ron. As always, we are looking for quality properties at good values. And we'll take them whether they are full, they are empty, they are leveraged or unleveraged. We're just -- we're looking for what we always look for and, again, that's quality properties at good values.

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

Hi, good afternoon. Can you comment on your strategy for media and commercial spending in 2008, and should we expect a decline in total spending over 2007, since you are not working as aggressively to lease up Shurgard?

Well, let me step back. Big picture, we still think the combined portfolios have 200 to 300 basis points of occupancy to grow to reach what we would consider full, on annualized basis. So we are continuing to aggressively fill up both the legacy and Public Storage properties, and the Shurgard properties. What's happened is the occupancy gap, which I think was close to 500 to 600 basis points at the time of acquisition, has narrowed considerably, and that should moderate the cannibalization that took place in a lot of submarkets in 2007. So that cannibalization should be reduced in '08.

We will -- going into '08, like I said, we have 200 to 300 bases points of occupancy to go, so we will continue to be aggressive on the media and promotional stint. Q4 was down. The reason for that is really in Q4 '06, we spent very aggressively on both national TV and cable, and quite frankly, I was disappointed with the results. So we dialed that down in Q4 '07. It did probably cost us some customer volumes in Q4 '07, but that was the trade-off vis-a-vis the reduced media spin.

Thank you.

Thank you. Our next question is coming from Craig Melcher of Citi.

I'm here with Michael Bilerman as well. Your core FFO increased actually from 3Q to 4Q by $0.03, which you look back didn't always occur, and some of that seemed to be on the operating expense side, particularly it looks like it might have been on the property taxes. Can you comment if there was anything one-time in the property taxes that we won't suspect to occur going forward?

Craig, the property taxes in the fourth quarter, we had -- essentially what happened was in the fourth quarter property tax bills were coming in -- the amount of the bills were coming in less than we had anticipated. So as a result of that, in the fourth quarter, we have to make adjustments to our overall property tax spends year-to-date to get it in line with what the actual bills were coming out to be. Two particular states that kind of swung it for us was Texas as well as Florida. We were estimating higher growth in property tax expense in those two states than what the actual bills came in at. So that's what happened with respect to property taxes.

What was the magnitude of that, for those two states?

Well, I don't know specifically the two states, how much, but they are primarily the bulk of the change.

Thank you.

Thank you. Our next question is coming from Christeen Kim of Deutsche Bank.

Thank you. Could you just talk about the share repurchases that you did earlier this year, and how much your appetite for your own stock has changed, following up?

Well, the share repurchases are really predicated on the price. Well, first of all, the -- you have to have the financial capacity to undertake them, so that's, like, criteria one. Once you get past that, then criteria two is what is the price? And criteria three is what are our alternative uses of capital? Our preferred deployment of capital is not really in share repurchases. It's in expanding the portfolio, but if opportunities aren't available or the pricing on opportunities available aren't as good as share repurchases, that's where we tend to deploy capital. Again with the caveat, you have to find have the capacity to do that. We don't generally, when we do share repurchases, we have different estimates of kind of what the intrinsic business value is, and, you know, we like some margin of error in that, so we tend to have not only what is the value, but some discount to that value when we undertake share repurchases.

Thank you.

Our next question is coming from Jeff Donnelly of Wachovia Securities.

Hi, guys. Ron, what is the institutional invest or appetite for storage investments these days? I guess wholly owned or through joint ventures, and what specifically are the unleveraged returns they might be seeking?

Well, we have good interest in people, institutions partnering with us, in terms of joint ventures, whether it's in Europe or in the U.S. on self-storage. So I would have to say it's strong. There's no shortage of capital in that regard. The returns vary by investor type. Some institutions want leveraged structures. Some want development structures where they have the opportunity to develop properties, and some want kind of vanilla acquisitions, no leverage, and the returns vary with kind of the degree of risk in each of those structures. Now, what I've heard is that there are a number of institutions that have been doing this not -- not what I would consider the traditional pension plans but a number of other people, more opportunistic institutional investors, that have been pulling back from their JVs or working to liquidate their JVs, that have been investors in self-storage, especially on the development side, and what I have been told is that returns have not been achieved, and it's leaving a little bit of a bad taste in people's mouths. Does that give you kind of color?

It does. I guess I was asking more specifically about required returns, unlevered returns, whether or not they opt to use leverage on more vanilla acquisitions, existing asset acquisitions?

Oh, I think, again, it depends -- I could think of three different pension plans in my mind and each one of them has different returns for that, or a different appetite, and one wouldn't do it without leverage, and the other one wants no leverage in the structure. And so you go from returns between 7 or 8, to 12.

That's helpful. Thank you.

Thank you. Our next question is coming from David Toti of Lehman Brothers.

Good afternoon. Just a quick question. You have seen any changes in customer behavior, in terms of shorter length of stays, further concession, expectations, or any kind of changing dynamic given the economic situation?

David, this is John. I mean, our existing customer base seems to be turning over at a slower rate than it has in the past. The length of stay seems to be extending out longer. Our aging of our existing portfolio is getting older, which is all good stuff for us. It's really the customer volume coming in the door has slowed down a little bit, but I think overall, the tenant base itself is aging along pretty nicely. As for concessions, we're giving away about the same amount of concessions with the dollar special of this year as we were last year.

Great. Thank you.

Thank you. Our next question is coming from Chris Pike of Merrill Lynch. [ Silence ] Chris, your line is live. Thank you. Our next question is coming from Michael Salinsky of RBC.

Hi, good afternoon. Ron, in the fourth quarter, you seemed to get a little bit better traction with the push in rental rates in your same store portfolio. Could you talk about how aggressive you plan to be for fiscal year in '08 in terms of pushing rental rates, versus - the existing tenants versus new rents?

Well, I should really let John answer that question, since John does all the pricing here. So I will give you a simplified answer and John can expand on it. It's a trade-off, and that's why we have the metric called REVPAF because we don't manage just to occupancy and we don't manage just to rates. We are managing to drive revenue, overall revenue of the property up. And as you are trying to fill up the property, you are more aggressive on rates and once it reaches a stabilized occupancy, 90, 92%, you could be more aggressive on the rates as you are approaching that point. John, do you have anything?

Yes. Not a whole lot to add to that. In terms of market brands, it's really going to be dictated by the demand obviously, and the supply that we have. So, you know, we reprice our product constantly and, again, it's demand-based and what is available. So depending on how the year progresses will dictate how aggressive you become on pricing.

With our existing tenant base, sending out rental rate increases to them this year, I -- we probably said that we will be as aggressive as we were last year. We haven't really made significant changes with respect to that. Again, in kind of touches upon what I mentioned in the last question, is that our tenant base is aging nicely, notwithstanding the fact that we are sending rental rate increase letters out, which kind of gives us an indication that the elasticity of their length of stay is pretty darn good that we can send increases out and still see the tenant base age longer.

With regard to street rates?

Street rates, again, is going to be dependent upon demand coming in the door. So, you know, I can't tell you what it's going to be, because I can't tell you what demand is going to be, you know, next month or the month after that.

Okay. Thanks, guys.

Thank you.

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Our next question is coming from Michael Knott of Green Street Advisors.

Hey, guys. If the year-over-year occupancy declines accelerate a little bit more, do you tell feel like rent growth can sort of win that battle and keep revenue growth positive into '08?

Well, Michael, if you think of -- let's take Florida. Florida is down, as I mentioned. So rates are down in Florida, as we try to get market share and drive the customer volumes into the properties, and basically reach a higher occupancy level. So one of the things with the Shurgard portfolio last year is we had a lot of space to fill up in those properties, and a number of them were in the same submarkets as our properties, so you had rate reductions on the Shurgard, which cannibalized the Public Storage properties, which impacted them adversely. As both portfolios have now filled up, I would expect less of that going into 2008. But all other things being equal, when demand abates, pricing comes down. When demand is strong, you have better pricing power. Is that --

Thank you.

Does that answer your question?

Yes, thank you.

Thank you. Our next question is coming from Mark Biffert of Goldman Sachs.

Hi, guys. Ron, in the past you had mentioned that, you know, the days of seeing the 4 to 6% NOI growth may be past, and it may be the case for a downturn in '08. How do you feel now, given what you see in the macro environment? Do you think it will come down to the 2% range where you had mentioned in the past?

If I remember my comment, I -- I didn't think 5% was a bygone. I just thought it would take a while to get there. I didn't expect it any time in the immediate future. I like what I'm seeing in '08, what we are seeing in Q4, even with the moderation in the advertising but, you know, we are almost through February, so I like what I see in '08. John touched on our -- our customer length of stay. Those are great things to see. We have sent out some rate increase letters, and see no degradation in length of stay or uptick in customer churn from that. So those are also positive things as well.

Does that mean you think you can achieve that 4 to 5% again this year?

I'm -- now you are making predictions.

Okay. Thanks.

Thank you. Our next question is coming from David Cohen of Morgan Stanley.

Hey, Ron, you just touched on this a little bit, but you did bring down your advertising expense quite a bit, whether sequentially and year-over-year. I'm just furious as to why you made that decision?

Yes, the -- in the -- hold on a sec. I will give you some stats here. Q4 of last year, was the first quarter of the Shurgard merger, and first quarter that we had -- we closed the merger in August of 2006. We gave the operating folks 30 to 45 days to kind of get things in place, and then we really stepped on it starting in October of '06, with both our regular national media, local television, as well as we went national cable, cross-country for October, November, December as well as some radio. I mean, we really just stepped on the gas in Q4 of last year. As you know, our business is seasonal and so when you are advertising around Christmas, there's not a lot of people moving. So I would say that that was a bad expenditure of money. Certainly in December of '06. As we got the results in and saw what happened and the momentum, or lack of momentum really, carried in January of '07, we said, okay, well, coming into 2006 -- or 2007, we're going to take a hard look at Q4 advertising; which months, which markets we are going to do it, and we really scratched our heads in terms of the efficacy of the cable buy. I'm not saying cable is ineffective, but I don't think it was effective for us in Q4 of '06. So that's really the reason we dialed back, and you could classify it as an error in Q4 of '06, versus a big change of strategy. In January, we're on TV here, in February, so we're back to our regular aggressive media programs here into 2008.

Can you just talk about -- you usually talk about the lag effect of that. You usually talk about three months or so. Can you give us more color on what you are seeing and the impact of that, lower expenses, if there is any?

The lower expense in Q4?

Yes, like when would we see that potentially hit, you know, occupancy numbers?

Well, you saw it in [year-end]. The customers react to the media spin within two to three weeks. You either have a need for storage today or you don't. We're out there, so we're trying to keep top of the mind awareness, but the movement that you will see on the advertising is fairly immediate, and our media spin was really dialed down in November and completely absent in December. So it's reflected in the year-end numbers.

Great. Thanks.

Thank you. Our next question is coming from Michael Mueller of JP Morgan.

Hi. One other John question here. If the sale of the European interest goes through, do you think you will take out a Series V?

I don't know, Mike. We haven't thought about it enough to answer that question.

Okay. Thanks.

But I would say probably this, Mike. Our past practice is to take out a preferred with another preferred stock. We kind of don't want to take that Series V out because it would deleverage our balance sheet, which as you know would impact our earnings growth to some degree. So we typically would not do that, but that's not to say that's not an option available to us.

Okay. Thanks.

Thank you. Our next question is coming from Jeff Donnelly of Wachovia Securities.

I will stick with you, John. Concerning your newly increased dividend, can you share with us where you see that relative to your expected taxable income? For instance, can we assume that that's roughly at the minimum now?

You know what, our dividend policy, I think we stated in the past is we distribute the minimum amount necessary to maintain our REIT status. I will leave it at that.

Okay. Great. Thanks.

Thank you. Our next question is coming from John Calone of Merrill Lynch.

Actually it's Chris. I know it's a small amount here and I'm just curious. With respect to the advertising, how do you allocate certain expenses that are shared across markets like advertising? I mean, you look at the same store pool, it was down, you know, 37%. I'm just wondering how do you allocate that cost across same store and non-same store assets, presumably that they are operating in the same markets?

We could -- you know, we are kind of simple on that. We just allocate it across the number of properties within the market. So we spend, you know, $100,000 here in Los Angeles and we have close to 200 properties, it's allocated equally among each of the properties.

Okay.

Thank you. Our next question is coming from Michael Salinsky of RBC.

Good afternoon. Real quickly, was there any updates with regard to litigation in Europe, with your two joint venture partners during the quarter, or should we expect to see resolution in 2008?

I think there will be a paragraph or something in the 10-K. One, the first JV, by its terms, I think terminates in May of this year, but the JV partner has the right to extend it a year, I believe. And the second JV is by its terms in 2009, and they have a similar extension in the -- so that's by its terms. And then the arbitration is scheduled sometime in the -- in the second quarter, I believe.

Okay. Thanks.

Thank you. Our next question is coming from Christine Kim of Deutsche Bank.

Going back to your commentary, Ron, on how you guys have been looking at the efficacy of TV advertising, are you finding that it's more effective in certain markets than others?

Yes.

Such as?

Probably -- you probably want a little bit more color on that, yes?

Probably.

Yes, it's funny because the marketing team has really gotten into it this year in terms of by market because we -- you know, we've had a lot of space to fill up with the Shurgard merger and so we have been really paying attention and obviously with Florida soft, we have been really figuring out how are we going to get Florida moving and how can we do that? So the marketing team has sliced and diced various markets, and we find that certain markets respond really unbelievably well to the media. Some average, and some we scratch our heads, and why do we waste our money? And I'd share that with you but it's kind of proprietary information, in terms of how we analyze it, but it is intuitive to what you said. So in those markets where we tried different things, whether it's radio, whether it's TV, whether it's cable, and we get no results, I mean we basically just stop and, you know -- there's no media spin there. And markets where we need the media, where we have a fair amount of vacancy, and it works well, we hit those markets pretty hard with the TV. The other kind of tool in our box here is the Internet, and that works also varying degrees of success in various markets. So we are able to dial that around as well.

Is the media spin working in Florida?

I give Florida a C plus to B minus. It's improving. It was a D, but it's working its way up to a C plus, B minus.

Okay. Great. Thanks.

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

If we go back to the beginning, or at the point in time when you consummated the Shurgard merger. How is the performance of that deal done relative to your expectations? It seems like the operating side has done phenomenally well. The overhead costs have been a little higher than you initial anticipated, but what is your overall assessment of that deal and then if it's positive, does that whet your appetite for additional M&A activity?

I was going to say, this question can't just stop with [an answer], right? I think -- my assessment of the merger is it has worked out far better than we have anticipated. There were things in will deal that we did not count on, that have been quite -- quite rewarding. By far the standout there is Europe. We got a great management team in Europe. They quickly grasped the operating strategy here in the U.S. They quickly implemented it. We sent a guy over there. He tells them to implement it, but the European management team, and the results out in Europe were just far, far in excess of anything that we anticipated.

In the U.S. operations, we've taken more costs out than I think we anticipated. The fill up of the portfolio has been a little more challenging probably than we anticipated, but that will happen over time, and the operating team is reinvigorated with some new scale strategy this year. We are heavy on the marketing, so I think that will play out and we'll get the top line here in '08 and '09.

So overall, I think the merger is just -- just a fantastic transaction for the company. And you really see it here Q4 '07 to Q4 '06, apples to apples, you can really see the benefits of the merger play out in the numbers. And our ancillary businesses have benefited as well. The key to the merger, obviously, is financial capacity, great troops in the field, great operating personnel. We've restored the strength of our operating organization. We have far more turnover in the Shurgard merger than we anticipated, and that really depleted our bench, but the operating team has done a great job of rebuilding the bench this year. A lot of hiring has gone on and we are back up to full strength. Turnover is moderating. So we are positioned well to do something else if it -- if it makes sense.

Thanks.

Thank you. At this time, there appears to be no further questions. I will turn the floor back over to Clem Teng for any closing remarks.

Thank you. I want to thank everybody for participating in our call and we'll talk to you next quarter. Thank you.

Thank you. This does conclude today's Public Storage conference call. You may now disconnect.