Public Storage (PSA) Q4 2007 Earnings Report, Transcript and Summary

Good afternoon. My name is Julian, and I will be your conference operator today. At this time, I would like welcome everyone to the Public Storage Fourth Quarter 2007 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions]. Thank you. It's now my pleasure to turn the phone 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, 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 risks and the uncertainty 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 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 28, 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 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 web site at www.publicstorage.com. Now, I will turn it over to John Reyes.

Thank you, Clem. For the fourth quarter of 2007, funds from operation 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 the 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 was primarily driven by improvements in net operating income generated from each of our groups of properties. For the fourth quarter of 2007, net operating income for 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 control. The European market presents us with 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 efficiency. 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 topline growth. Florida makes up approximately 10% of our combined same-store domestic portfolio and reduced our overall topline growth by about 50 basis points. Partially offsetting Florida was Phoenix, Los 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 continued to perform exceptionally well. Having adopted many of our U.S. best practices, Europe finished the year with topline growth of 9%. 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 at 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. 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. Question and Answer

Thank you. [Operator Instructions]. Thank you. Our first question is coming from Michael Mueller of JPMorgan.

Yes, hi. A question looking at the ancillary income, I mean if we look back either on a year-over-year basis as well as sequentially, I mean the historical run rate has been quite about $20 million to $21 million, $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 year, does it seem like the fourth quarter on the expense side was more of an anomaly or just something we should think about going forward?

Well, going forward, it is all going to 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 predict what those numbers might be going forward.

Okay. Thanks.

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

Hi, good afternoon. You talked about... that you're open the 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... we always look for… and again, that's quality properties at good values.

Thank you. Our next question is coming from Christy McElroy of Bank 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 a full [ph] on an annualized basis. So we are continuing to aggressively [inaudible] the legacy Public Storage properties and the Shurgard property. What happened is the occupancy gap, which I think was close to 500 or 600 basis points point at the time of acquisition, has narrowed considerably and that should moderate the cannibalization that took place in a lot of sub-markets in 2007. So that cannibalization should be reduced in '08. We will… going into '08 though, like I said we have 200 to 300 basis points of occupancy to grow. So we will continue to be aggressive on the media and promotional spend. 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 [inaudible] that down in Q4 '07. It probably cost us some customer volumes in Q4 '07, but that was the trade off vis-à-vis the reduced media spend.

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 was increased actually from 3Q to 4Q by $0.03, which in fact didn't always occur, and some of that seems 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, essentially what happened was that in the fourth quarter property tax bills were coming and the amount of the bills were coming in less than we had anticipated. So as a result of that in the fourth quarter we had to make adjustments to our overall property tax expense year-to-date to get it in line with what the actual bills were coming out to be. Two particular states 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's the magnitude of that for those two states?

I don't know specifically the two states are 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 of your appetite for your own stock has changed following that?

It was... the share repurchases are really predicated on the price. Well, first of all, 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 is 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 caveat, you have got to have the financial 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 we like some margin aware 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's the institutional investor appetite for storage investments these days, I guess wholly owned or through joint ventures and much 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 for in the US or self storage. So I would have to say it's strong. There is no shortage of capital in that regard. The returns vary by investor type. Some institutions want leverage 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 what I would consider the traditional pensions 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’ve been told is that returns have not been achieved and it's leaving a little bit of a bad taste in people's mouth. Does that give you a kind of a color?

It does. I guess I was asking more specifically about, call it, required returns and other returns, whether or not they opt to use leverage on more vanilla acquisition… existing asset acquisitions.

Well, I think that the... again, it depends… I mean, I can think of like three different pension plans in my mind and each one of them has different returns for that or different appetite. And one won’t do 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. Have you guys seen any changes in customer behavior in terms of shorter lengths of stays, further concession expectations, or just any kind of changing dynamic given economic situation?

David, this is John. Our existing customer base seems to be turning over at a slower rate than it has in the past. Length of stay seems to be extending out longer. Our ageing 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 ageing along pretty nicely. As for concession, we're given about... we are giving away about the same amount of concessions with the dollar special this year as we were last year.

Great. Thank you.

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

Good afternoon. Ron, in the fourth quarter you've seen again a little better traction with the pushing rental rates on your same-store portfolio. Can you talk about what... how aggressive you plan it be for fiscal year '08 in terms of pushing rental rates versus your existing... 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 then John can expand on it. It is a trade-off and that's why we have the matrix call RevPAF because we don't manage just occupancy and we just don't manage... just rates, we're managing to drive the revenue… overall revenue of the property up and as it... as you are trying to fill up a property you're more aggressive on the rates and once it reaches stabilized occupancy, 90%, 92%, you can be more aggressive on the rates and… as you are approaching that point. John, do you have any thing?

Yes, I do... not a whole lot to add to that. I mean, in terms of market rents, it's really going to be dictated by the demand obviously and the supply that we have. So we re-price our products constantly and again it's demand based and what's available. So depending on how the year progress... dictated how aggressively become a pricing with the... our existing tenant base sending out rental rate increase letters them. This year I... we’re probably sent… we’re probably as aggressive as we were last year. We haven't really made significant changes with respect to that. Again, it kind of touches upon what I mentioned in the last question is that our tenant basis ageing nicely, notwithstanding the fact that we are sending around rate increase letters, which kind of gives us an indication that the elasticity of their length of stay is pretty darn good that we can then increase that and still see the tenant base age longer.

Okay, and with regard to street rates?

Well, street rates again is going to be depending on demand coming in the door so... I can't tell you what it is going to be because I can’t tell you what demand is going to be next month or the month after that.

Okay. Thanks, guys.

Thank you. [Operator Instructions]. Our next question is coming from Michael Maar of Green Street Advisory [ph].

Hi, guys. If the year-over-year occupancy declines accelerate a little more, do you still 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 just like 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 on that. So one of the things with the Shurgard portfolio last year is we had a lot of space to fill up in those properties. A number of them more in the sub-markets as our properties. So you had reproductions on the Shurgards, 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 come down and when demand is strong you have better pricing power. You got the answer to your question?

Yes, thank you.

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

Hi, guys. Ron, in the past you had mentioned that the days have seen the 4% to 6% NOI growth, maybe in case for a downturn in '08. How do you feel now, given what you're seeing in the macro environment? Do you think it's going to come down that 2% range where you'd mentioned in the past?

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

But does that you mean you think you can achieve that for... to 4% to 5% again this year?

I'm not going to make a prediction.

Okay, thanks.

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

Hi, 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, just curious as to why you made that decision?

Yes, in the… Q4 of last year was first quarter of the Shurgard merger and the first quarter that we had… we closed the merger in August 2006. We gave the operating folks to 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 regular national media, local television as well as we went national cable cross country for October, November, December as well as 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're advertising around Christmas there is not a lot of people moving. So I'd say that that was a bad expenditure of money certainly in December of '06. As we got the results in and saw what happened in the momentum or lack of momentum, really it carried into January of '07, we said, okay, well coming into 2006 or 2007 we are going to take a hard look at Q4 advertising, which months, which markets we are going to do it, and we really scratched our head in terms of the efficacy of the cable buys. And I'm not saying cables are 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 I'd... you could almost classify it as an error in Q4 of '06 versus a big change of strategy. We are on TV in January, we are on TV here in February, and so we are back to kind of our regular aggressive media programs here into 2008.

Okay. And can you just talk about the... you usually about a lag effect of that, I think you usually talk about three months or so. Can you give some more color on what you're seeing the impact of that lower expenses, if there is any?

The lower expense in Q4?

Yes, like when would we see that potentially hit occupancy numbers or--?

[inaudible], I mean the customers react to the media spend within two to three weeks, and you either have a need to storage day or you don't, we are out there so we are trying to keep top of the mind awareness, but the movement that you'll see in the advertising is fairly immediate and so our media spend was really 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 JPMorgan.

Hi, one other John question here. If the sale the European interest goes through, do you think you will take out the Series B?

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

Okay, thanks.

I would say probably this is my… our past practice was basically to take out a preferred with another preferred stock. We kind of don't want to take that Series B out. 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 that’s not an option available to us.

Okay, thanks.

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

I'll 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 is roughly at the minimum now?

Well, you know what, our dividend policy as I think we have stated in the past, we’ve distributed the minimum amount necessary to maintain our REIT status, and I will leave it that.

Okay, great. Thanks.

Thank you. Our next question is coming from John Connie [ph] of Merrill Lynch.

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

We are kind of simple in that. We just allocate it across a number of properties within the market. So if we spend 100,000 here in Los Angeles and we have close to 200 properties, it is 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 update with regard to litigation in Europe with your two joint venture partners during the quarter, or should we expect to see any resolution in 2008?

I think there'll be a paragraph or something in the 10-K, one JV… the first JV by it's 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 ends 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 second quarter I believe.

Okay, thanks.

Thank you. Our next question is coming from Christeen 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?

You probably want a little more color on that, --?

Probably.

Yes. It's funny because the marketing team has really gotten into it this year in terms of by market because we have a lot of space to fill up with the Shurgard merger and so we’ve been really paying attention. And obviously with Florida soft, we have been really figuring out, okay, are we going to get Florida moving and how can we do that. So the marketing team has kind of 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 so... I’d share that with you, but it is kind of proprietary information in terms of how we analyze it. But it is intuitive to what you said. And so in those markets where we have tried different things, whether it's radio, whether it's TV, whether its cable we get no results. I mean we basically just stop and there is no media spend 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 TV. The other tool in our box here is the Internet and that works also with varying degrees of success in various markets. That's how we are able to dial that around as well.

Is the media spend working in Florida?

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

Great. Thanks.

Thank you. Our next question is coming from Michael Maar of Green Street Advisory [ph].

Hi, guys. If we go back to the beginning… at the point on time when you consummated the Shurgard merger, how was 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 had initially anticipated. So what's your overall assessment of that deal? And then if it's positive, does that whet your appetite for additional M&A activity?

I’m going to take this question and [inaudible]. I think the... my assessment of the merger is it's worked out far better than we anticipated. There were things in the deal that we did not count on that have been quite rewarding. By far the standout there was 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 helped them implement it, but the European management team and the [inaudible] Europe were just 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 sales strategy this year and were heavy on the marketing. So I think I think that will play out and we'll get the topline here in '08 and '09. So overall, I think the merger is 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 had 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 going on, and we’re back up to full strength, turnover is moderating. So we are positioned well to do something else if it makes sense.

Thanks.

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

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

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