Public Storage - Quarter Report: 2014 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

[X]Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2014

or

[   ]Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to .

Commission File Number:  001-33519

PUBLIC STORAGE
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (818) 244-8080.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.

[X]  Yes  [   ]  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

[X]  Yes  [   ]  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

[   ]  Yes  [X]  No

 

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Indicate the number of the registrant’s outstanding common shares of beneficial interest, as of May 1, 2014:

Common Shares of beneficial interest, $.10 par value per share – 172,539,982 shares

 

 

 

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1.Description of the Business

Public Storage (referred to herein as “the Company”, “we”, “us”, or “our”), a Maryland real estate investment trust, was organized in 1980.  Our principal business activities include the acquisition, development, ownership and operation of self-storage facilities which offer storage spaces for lease, generally on a month-to-month basis, for personal and business use. 

At March 31, 2014, we have direct and indirect equity interests in 2,202 self-storage facilities (with approximately 141 million net rentable square feet) located in 38 states in the United States (“U.S.”) operating under the “Public Storage” name.  In Europe, we own one self-storage facility in London, England and we have a 49% interest in Shurgard Europe, which owns 187 self-storage facilities (with approximately 10 million net rentable square feet) located in seven Western European countries, all operating under the “Shurgard” name.  We also have direct and indirect equity interests in approximately 31 million net rentable square feet of commercial space located in 11 states in the U.S. primarily owned and operated by PS Business Parks, Inc. (“PSB”) under the “PS Business Parks” name.  At March 31, 2014, we have an approximate 42% common equity interest in PSB.

Disclosures of the number and square footage of properties, as well as the number and coverage of tenant reinsurance policies are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the Public Company Accounting Oversight Board (U.S.).

2.Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim financial statements were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) as defined in the Financial Accounting Standards Board Accounting Standards Codification (the “Codification”), including guidance with respect to interim financial information and in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X.  While they do not include all of the disclosures required by GAAP for complete financial statements, we believe that we have included all adjustments (consisting of normal and recurring adjustments) necessary for a fair presentation.  Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 due to seasonality and other factors.  These interim financial statements should be read together with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Consolidation and Equity Method of Accounting

We consider entities to be Variable Interest Entities (“VIEs”) when they have insufficient equity to finance their activities without additional subordinated financial support provided by other parties, or where the equity holders as a group do not have a controlling financial interest.  We have no investments or other involvement in any VIEs. 

We consolidate all entities that we control (these entities, for the period in which the reference applies, are referred to collectively as the “Subsidiaries”), and we eliminate intercompany transactions and balances.  We account for our investments in entities that we have significant influence over, but do not control, using the equity method of accounting (these entities, for the periods in which the reference applies, are referred to

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collectively as the “Unconsolidated Real Estate Entities”).  When we obtain control of an Unconsolidated Real Estate Entity, we commence consolidating the entity and record a gain representing the differential between the book value and fair value of our preexisting equity interest.  All changes in consolidation status are reflected prospectively.

When we are general partner, we control the partnership unless the third-party limited partners can dissolve the partnership or otherwise remove us as general partner without cause, or if the limited partners have the right to participate in substantive decisions of the partnership. 

Collectively, at March 31, 2014, the Company and the Subsidiaries own 2,188 self-storage facilities in the U.S., one self-storage facility in London, England and six commercial facilities in the U.S.  At March 31, 2014, the Unconsolidated Real Estate Entities are comprised of PSB, Shurgard Europe, as well as limited partnerships that own an aggregate of 14 self-storage facilities in the U.S. (these limited partnerships, for the periods in which the reference applies, are referred to as the “Other Investments”).

Use of Estimates

The financial statements and accompanying notes reflect our estimates and assumptions.  Actual results could differ from those estimates and assumptions.

Income Taxes

We have elected to be treated as a real estate investment trust (“REIT”), as defined in the Internal Revenue Code.  As a REIT, we do not incur federal income tax if we distribute 100% of our REIT taxable income (generally, net rents and gains from real property, dividends, and interest) each year, and if we meet certain organizational and operational rules.  We believe we will meet these REIT requirements in 2014, and that we have met them for all other periods presented herein.  Accordingly, we have recorded no federal income tax expense related to our REIT taxable income.

Our merchandise and tenant reinsurance operations are subject to corporate income tax and such taxes are included in ancillary cost of operations.  We also incur income and other taxes in certain states, which are included in general and administrative expense. 

We recognize tax benefits of uncertain income tax positions that are subject to audit only if we believe it is more likely than not that the position would ultimately be sustained assuming the relevant taxing authorities had full knowledge of the relevant facts and circumstances of our positions.  As of March 31, 2014, we had no tax benefits that were not recognized. 

Real Estate Facilities

Real estate facilities are recorded at cost.  We capitalize all costs incurred to develop, construct, renovate and improve properties, including interest and property taxes incurred during the construction period.  We expense internal and external transaction costs associated with acquisitions or dispositions of real estate, as well as repairs and maintenance costs, as incurred.  We depreciate buildings and improvements on a straight-line basis over estimated useful lives ranging generally between 5 to 25 years.

We allocate the net acquisition cost of acquired operating self-storage facilities to the underlying land, buildings, identified intangible assets, and remaining noncontrolling interests based upon their respective

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individual estimated fair values.  Any difference between the net acquisition cost and the estimated fair value of the net tangible and intangible assets acquired is recorded as goodwill.    

Other Assets

Other assets primarily consist of prepaid expenses, accounts receivable, land held for sale and restricted cash. 

Accrued and Other Liabilities

Accrued and other liabilities consist primarily of trade payables, property tax accruals, tenant prepayments of rents, accrued interest payable, accrued payroll, accrued tenant reinsurance losses, casualty losses, and contingent loss accruals which are accrued when probable and estimable.  We disclose the nature of significant unaccrued losses that are reasonably possible of occurring and, if estimable, a range of exposure.

Cash Equivalents, Marketable Securities and Other Financial Instruments

Cash equivalents represent highly liquid financial instruments such as money market funds with daily liquidity or short-term commercial paper or treasury securities maturing within three months of acquisition.  Cash and cash equivalents which are restricted from general corporate use are included in other assets.  Commercial paper not maturing within three months of acquisition, which we intend and have the capacity to hold until maturity, are included in marketable securities and accounted for using the effective interest method.    Transfers of financial assets are recorded as sales when the asset is put presumptively beyond our and our creditors’ reach, there is no impediment to the transferee’s right to pledge or exchange the asset, we have surrendered effective control of the asset, we have no actual or effective right or requirement to repurchase the asset and, in the case of a transfer of a participating interest, there is no impediment to our right to pledge or exchange the participating interest we retain.

Fair Value Accounting

As used herein, the term “fair value” is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  We prioritize the inputs used in measuring fair value based upon a three-tier hierarchy described in Codification Section 820-10-35. 

We believe that, during all periods presented, the carrying values approximate the fair values of our cash and cash equivalents, marketable securities, other assets, and accrued and other liabilities, based upon our evaluation of the underlying characteristics, market data, and short maturity of these financial instruments, which involved considerable judgment.  The estimated fair values are not necessarily indicative of the amounts that could be realized in current market exchanges.  The characteristics of these financial instruments, market data, and other comparative metrics utilized in determining these fair values are “Level 2” inputs as the term is defined in Codification Section 820-10-35-47.

We use significant judgment to estimate fair values in recording our business combinations, to evaluate real estate, investments in unconsolidated real estate entities, goodwill, and other intangible assets for impairment, and to determine the fair values of notes payable and receivable.  In estimating fair values, we consider significant unobservable inputs such as market prices of land, market capitalization rates and earnings multiples for real estate facilities, projected levels of earnings, costs of construction, functional depreciation,

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and market interest rates for debt securities with a similar time to maturity and credit quality, which are “Level 3” inputs as the term is defined in Codification Section 820-10-35-52. 

Currency and Credit Risk

Financial assets that are exposed to credit risk consist primarily of cash and cash equivalents, accounts receivable, loans receivable, and restricted cash.  Cash equivalents and marketable securities we invest in are either money market funds with a rating of at least AAA by Standard and Poor’s, commercial paper that is  rated A1 by Standard and Poor’s or deposits with highly rated commercial banks.

At March 31, 2014, due primarily to our investment in and loan receivable from Shurgard Europe, our operating results and financial position are affected by fluctuations in currency exchange rates between the Euro, and to a lesser extent, other European currencies, against the U.S. Dollar.

Goodwill and Other Intangible Assets

Intangible assets are comprised of goodwill, the “Shurgard” trade name, acquired customers in place, and leasehold interests in land.

Goodwill totaled $174.6 million at March 31, 2014 and December 31, 2013.  The “Shurgard” trade name, which is used by Shurgard Europe pursuant to a fee-based licensing agreement, has a book value of $18.8 million at March 31, 2014 and December 31, 2013.  Goodwill and the “Shurgard” trade name have indefinite lives and are not amortized.

Acquired customers in place and leasehold interests in land are finite-lived and are amortized relative to the benefit of the customers in place or the land lease expense to each period.  At March 31, 2014, these intangibles have a net book value of $38.8 million ($53.4 million at December 31, 2013).  Accumulated amortization totaled $42.4 million at March 31, 2014 ($35.1 million at December 31, 2013), and amortization expense of $14.6 million and $2.6 million was recorded in the three months ended March 31, 2014 and 2013, respectively.  The estimated future amortization expense for our finite-lived intangible assets at March 31, 2014 is $22.0 million in the remainder of 2014, $8.2 million in 2015 and $8.6 million thereafter.  During the three months ended March 31, 2013, intangibles were increased $0.3 million, in connection with the acquisition of self-storage facilities and leasehold interests. 

Evaluation of Asset Impairment

We evaluate our real estate, finite-lived intangible assets, investments in unconsolidated real estate entities, and loan receivable from Shurgard Europe for impairment on a quarterly basis.  We evaluate indefinite-lived assets (including goodwill) for impairment on an annual basis, or more often if there are indicators of impairment.

In evaluating our real estate assets and finite-lived intangible assets for impairment, if there are indicators of impairment, and we determine that the asset is not recoverable from future undiscounted cash flows, an impairment charge is recorded for any excess of the carrying amount over the asset’s estimated fair value.  For long-lived assets that we expect to dispose of prior to the end of their estimated useful lives, we record an impairment charge for any excess of the carrying value of the asset over the expected net proceeds from disposal.

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If we determine, based upon the relevant events and circumstances and other such qualitative factors, that it is more likely than not that the “Shurgard” trade name is unimpaired, we do not record an impairment charge and no further analysis is performed.  Otherwise, we record an impairment charge for any excess of carrying amount over quantitatively assessed fair value. 

In evaluating goodwill for impairment, we first evaluate, based upon the relevant events and circumstances and other such qualitative factors, whether the fair value of the reporting unit that the goodwill pertains to is greater than its aggregate carrying amount.  If based upon this evaluation it is more likely than not that the fair value of the reporting unit is in excess of its aggregate carrying amount, no impairment charge is recorded and no further analysis is performed.  Otherwise, we estimate the goodwill’s implied fair value based upon what would be allocated to goodwill if the reporting unit were acquired at estimated fair value in a transaction accounted for as a business combination, and record an impairment charge for any excess of book value over the goodwill’s implied fair value. 

For our investments in unconsolidated real estate entities, if we determine that a decline in the estimated fair value of the investments below carrying amount is other than temporary, we record an impairment charge for any excess of carrying amount over the estimated fair value. 

For our loan receivable from Shurgard Europe, if we determine that it is probable we will be unable to collect all amounts due based on the terms of the loan agreement, we record an impairment charge for any excess of book value over the present value of expected future cash flows.

No impairments were recorded in any of our evaluations for any period presented herein.

Revenue and Expense Recognition

Rental income, which is generally earned pursuant to month-to-month leases for storage space, as well as late charges and administrative fees, are recognized as earned.  Promotional discounts reduce rental income over the promotional period.  Ancillary revenues and interest and other income are recognized when earned.  Equity in earnings of unconsolidated real estate entities represents our pro-rata share of the earnings of the Unconsolidated Real Estate Entities. 

We accrue for property tax expense based upon actual amounts billed and, in some circumstances, estimates and historical trends when bills or assessments have not been received from the taxing authorities or such bills and assessments are in dispute.  If these estimates are incorrect, the timing and amount of expense recognition could be incorrect.  Cost of operations, general and administrative expense, interest expense, as well as television and other advertising expenditures are expensed as incurred. 

Foreign Currency Exchange Translation

The local currency (primarily the Euro) is the functional currency for our interests in foreign operations.  The related balance sheet amounts are translated into U.S. Dollars at the exchange rates at the respective financial statement date, while amounts on our statements of income are translated at the average exchange rates during the respective period.  The Euro was translated at exchange rates of approximately 1.375 U.S. Dollars per Euro at March 31, 2014 (1.377 at December 31, 2013), and average exchange rates of 1.370 and 1.320 for the three months ended March 31, 2014 and 2013, respectively.  Cumulative translation adjustments, to the extent not included in cumulative net income, are included in equity as a component of accumulated other comprehensive income (loss).

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Comprehensive Income (Loss)

Total comprehensive income (loss) represents net income, adjusted for changes in other comprehensive income (loss) for the applicable period.  The aggregate foreign currency exchange gains and losses reflected on our statements of comprehensive income are comprised primarily of foreign currency exchange gains and losses on our investment in, and loan receivable from, Shurgard Europe.

Discontinued Operations

In April 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard (ASU No. 2014-08) that requires us to classify as discontinued operations the operating results for those facility disposals that represent a strategic shift and have a major impact upon operations, as compared to presenting all facility disposals as discontinued operations under the previous standard.  Prospective application is required. As the standard encourages, we are early adopting the standard on January 1, 2014.  The adoption of ASU No. 2014-08 had no impact on our financial condition or results of operations.

Net Income per Common Share

Net income is allocated to (i) noncontrolling interests based upon their share of the net income of the Subsidiaries, (ii) preferred shareholders, to the extent redemption cost exceeds the related original net issuance proceeds (an “EITF D-42 allocation”), and (iii) the remaining net income is allocated to each of our equity securities based upon the dividends declared or accumulated during the period, combined with participation rights in undistributed earnings. 

Basic net income per share is computed using the weighted average common shares outstanding.  Diluted net income per share is computed using the weighted average common shares outstanding, adjusted for the impact, if dilutive, of stock options outstanding (Note 10). 

The following table reflects our net income allocable to common shareholders and the weighted average common shares and equivalents outstanding, as used in our calculations of basic and diluted net income per share, basic and diluted net income from discontinued operations per share, and basic and diluted net income from continuing operations per share:

 

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3.Real Estate Facilities

Activity in real estate facilities is as follows:  

 

 

We completed expansion and development activities during the three months ended March 31, 2014, adding 335,000 net rentable square feet of self-storage space, at an aggregate cost of $40.1 million.  Construction in process at March 31, 2014, consists of projects to develop new self-storage facilities and expand existing self-storage facilities, which would add a total of 1.9 million net rentable square feet of storage space, for an aggregate estimated cost of approximately $195 million.

 

 

 

4.Investments in Unconsolidated Real Estate Entities

The following table sets forth our investments in, and equity earnings of, the Unconsolidated Real Estate Entities (amounts in thousands):

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During the three months ended March 31, 2014 and 2013, we received cash distributions from our investments in the Unconsolidated Real Estate Entities totaling $12.9 million and $11.2 million, respectively. 

Investment in PSB

PSB is a REIT traded on the New York Stock Exchange.  We have an approximate 42% common equity interest in PSB as of March 31, 2014 and December 31, 2013, comprised of our ownership of 7,158,354 shares of PSB’s common stock and 7,305,355 limited partnership units (“LP Units”) in an operating partnership controlled by PSB.  The LP Units are convertible at our option, subject to certain conditions, on a one-for-one basis into PSB common stock.  Based upon the closing price at March 31, 2014  ($83.62 per share of PSB common stock), the shares and units we owned had a market value of approximately $1.2 billion. 

The following table sets forth selected financial information of PSB.  The amounts represent all of PSB’s balances and not our pro-rata share.

Investment in Shurgard Europe

For all periods presented, we had a 49% equity investment in Shurgard Europe and our joint venture partner owns the remaining 51% interest.   In addition, Shurgard Europe pays a license fee to Public Storage for the use of the “Shurgard” trademark and Public Storage has provided a loan to Shurgard (see Note 5).      

Changes in foreign currency exchange rates increased our investment in Shurgard Europe by approximately $0.3 million during the three months ended March 31, 2014, and decreased our investment by approximately $18.6 million during the three months ended March 31, 2013.     

The following table sets forth selected consolidated financial information of Shurgard Europe based upon all of Shurgard Europe’s balances for all periods,  rather than our pro rata share.  Such amounts are based upon our historical acquired book basis.

 

 

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As reflected in the table above, Shurgard Europe’s net income has been reduced by expenses it pays to its shareholders, including a trademark license fee and interest expense on the shareholder loan.  Our equity in earnings of Shurgard Europe for the three months ended March 31, 2014 and 2013, consists of our equity ownership (49%) of Shurgard Europe’s net income adjusted for 49% of the trademark license fee and interest paid to Shurgard Europe’s shareholders.  The following table set forth the calculation of our equity in earnings in Shurgard Europe:

 

Trademark license fees and interest paid to Public Storage in excess of our 49% equity ownership (in excess of the amounts in the above table) are included in “Interest and other income” on our Statements of Income.  These amounts totaled $0.3 million for trademark license fees and $1.5 million in interest for the three months ended March 31, 2014, as compared to $0.3 million for trademark license fees and $4.7 million in interest for the same period in 2013.  The reduction in excess interest during the three months ended March 31, 2014, as compared to the same period in 2013, is due to the sale, on January 28, 2014, of 51% of the shareholder loan to our joint venture partner reducing our ownership of the loan to 49% (see Note 5).

 

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Other Investments

At March 31, 2014, the “Other Investments” include an average common equity ownership of approximately 26% in various limited partnerships that collectively own 14 self-storage facilities.

The following table sets forth certain condensed combined financial information (representing 100% of these entities’ balances, rather than our pro-rata share) with respect to the Other Investments:

 

 

 

 

5.Loan Receivable from Shurgard Europe

At December 31, 2013, we owned 100% of the shareholder loan due from Shurgard Europe, which had a balance of €311.0 million ($428.1million).  On January 28, 2014, our joint venture partner in Shurgard Europe acquired a  51% interest in the loan at face value for €158.6 million ($216.2 million) in cash.  As of March 31, 2014, we owned a 49% interest in the loan, which had a balance of €311.0 million ($427.7 million). 

The loan bears interest at a fixed rate of 9.0% per annum and has no required principal payments until maturity in April 2019,  but can be prepaid in part or in full at any time without penalty.    

As a result of the sale of the interest in the loan, the 51% of the loan interest that we previously recorded as interest income ceased as of January 28, 2014, while the interest received with respect to our remaining 49% ownership of the loan is recorded as equity in earnings on our income statement (see Note 4).  For the three months ended March 31, 2014 and 2013, we recorded interest income with respect to this loan of approximately $1.5 million and $4.7 million, respectively.

Because we expected repayment of the loan in the foreseeable future for all periods presented, foreign exchange rate gains or losses due to changes in exchange rates between the Euro and the U.S. Dollar are recognized on our income statements as “foreign currency exchange gain (loss).”  We recognized a $2.3 million foreign currency exchange loss in the three months ended March 31, 2014, based upon the change in the U.S. dollar equivalent of the loan between December 31, 2013 and i) January 28, 2014, with respect to the 51% interest sold, and ii) March 31, 2014, with respect to our remaining 49% interest in the loan. In the same period in 2013, we recognized a foreign exchange rate loss totaling $12.7  million with respect to the loan.

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We believe that the interest rate on the loan approximates the market rate for loans with similar terms, conditions, subordination features, and tenor, and that the fair value of the loan approximates book value.  In our evaluation of market rates and fair value, we considered that Shurgard Europe has sufficient operating cash flow, liquidity and collateral, and we have sufficient creditor rights such that credit risk is mitigated.  Shurgard Europe has made a total of €80.9 million in principal repayments on this loan and paid all interest when due since its inception on March 31, 2008.    

6.Credit Facility, Term Loan and Notes Payable

We have a $300 million revolving line of credit (the “Credit Facility”) that expires on March 21, 2017.  Amounts drawn on the Credit Facility bear annual interest at rates ranging from LIBOR plus 0.900% to LIBOR plus 1.500% depending upon the ratio of our Total Indebtedness to Gross Asset Value (as defined in the Credit Facility) (LIBOR plus 0.900% at March  31, 2014).  In addition, we are required to pay a quarterly facility fee ranging from 0.125% per annum to 0.300% per annum depending upon the ratio of our Total Indebtedness to our Gross Asset Value (0.125% per annum at March 31, 2014).  At March 31, 2014 and May 2, 2014, we had no outstanding borrowings under this Credit Facility ($50.1 million at December 31, 2013).  We had undrawn standby letters of credit, which reduce our borrowing capacity, totaling $15.1 million at March 31, 2014 and December 31, 2013.  The Credit Facility has various customary restrictive covenants, all of which we were in compliance with at March 31, 2014.

On December 2, 2013, we entered into a one year $700 million unsecured term loan (the “Term Loan”) with Wells Fargo Bank, the lead arranger for our Credit Facility.  The Term Loan matures on December 2, 2014 and can be repaid in full or part at any time prior to its maturity without penalty.  The interest rate and covenants on the Term Loan are the same as for the Credit Facility.  At March 31, 2014, outstanding borrowings under this Term Loan totaled $372.0 million ($700.0 million at December 31, 2013), at an interest rate of 1.055%.  As of May 2, 2014, outstanding balances under this Term Loan totaled $322.0 million.  In connection with the Term Loan, we incurred origination costs of $1.9 million which are amortized over the one year period of the Term Loan using the effective interest method.  As of March 31, 2014, we had $0.7 million ($1.8 million as of December 31, 2013) of unamortized loan costs. 

The carrying amounts of our notes payable at March  31, 2014 and December 31, 2013, respectively, totaled $88.2 million and $89.0 million, with unamortized premium totaling $0.4 million and $0.5 million. These notes were assumed in connection with business combinations and recorded at fair value, with any premium or discount over the stated note balance amortized using the effective interest method.  At March 31, 2014, the notes have a 4.8% average effective rate, are secured by 45 real estate facilities with a net book value of approximately $222 million, have stated note rates between 2.9% and 7.1%, and mature between June 2014 and September 2028.

 

 

 

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At March  31, 2014, approximate principal maturities of our notes payable are as follows (amounts in thousands):

 

 

Cash paid for interest totaled $3.8 million and $4.3 million for the three months ended March 31, 2014 and 2013, respectively.  Interest capitalized as real estate totaled $0.2 million and $0.6 million for the three months ended March 31, 2014 and 2013, respectively.

7.Noncontrolling Interests

At March 31, 2014, third parties own i) interests in Subsidiaries that own an aggregate of 14 self-storage facilities, and ii) 231,978 partnership units in a Subsidiary that are convertible on a one-for-one basis (subject to certain limitations) into common shares of the Company at the option of the unitholder.  These interests are referred to collectively hereinafter as the “Noncontrolling Interests.”  At March  31, 2014, the Noncontrolling Interests cannot require us to redeem their interests, other than pursuant to a liquidation of the Subsidiary.

During the three months ended March 31, 2014 and 2013, we allocated a total of $1.1 million and $1.0 million, respectively, in income to these interests; and we paid $1.8 million and $1.7 million, respectively, in distributions to these interests. 

During the year ended December 31, 2013, we acquired Permanent Noncontrolling Interests for $6.2 million in cash, substantially all of which was allocated to paid-in-capital.

8.Shareholders’ Equity

Preferred Shares

At March 31, 2014 and December  31, 2013, we had the following series of Cumulative Preferred Shares (“Preferred Shares”) outstanding:

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The holders of our Preferred Shares have general preference rights with respect to liquidation, quarterly distributions and any accumulated unpaid distributions.  Except under certain conditions and as noted below, holders of the Preferred Shares will not be entitled to vote on most matters.  In the event of a cumulative arrearage equal to six quarterly dividends, holders of all outstanding series of preferred shares (voting as a single class without regard to series) will have the right to elect two additional members to serve on our Board of Trustees until the arrearage has been cured.  At March  31, 2014, there were no dividends in arrears.

Except under certain conditions relating to the Company’s qualification as a REIT, the Preferred Shares are not redeemable prior to the dates indicated on the table above.  On or after the respective dates, each of the series of Preferred Shares is redeemable at our option, in whole or in part, at $25.00 per depositary share, plus accrued and unpaid dividends.  Holders of the Preferred Shares cannot require us to redeem such shares.

Upon issuance of our Preferred Shares, we classify the liquidation value as preferred equity on our balance sheet with any issuance costs recorded as a reduction to paid-in capital.

During the three months ended March 31, 2014, we issued an aggregate 9.4 million depositary shares, representing 1/1,000 of a share of our Series Y Preferred Shares, at an issuance price of $25.00 per depositary share, for a total of $235.0 million in gross proceeds, and we incurred an aggregate of $7.5 million in issuance costs. 

During the three months ended March 31, 2013, we issued an aggregate 29.0 million depositary shares, each representing 1/1,000 of a share of our Series W and Series X Preferred Shares, at an issuance price of $25.00 per depositary share, for a total of $725.0 million in gross proceeds, and we incurred $23.3 million in issuance costs. 

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Dividends

Common share dividends including amounts paid to our restricted share unitholders totaled $241.7 million ($1.40 per share) and $215.1 million ($1.25 per share), for the three months ended March 31, 2014 and 2013, respectively.  Preferred share dividends totaled $52.5 million and $48.6 million for the three months ended March 31, 2014 and 2013, respectively.

9.Related Party Transactions

The Hughes Family owns approximately 15.7% of our common shares outstanding at March 31, 2014.

The Hughes Family has ownership interests in, and operates, approximately 54 self-storage facilities in Canada (“PS Canada”) using the “Public Storage” brand name pursuant to a non-exclusive, royalty-free trademark license agreement with the Company.  We currently do not own any interests in these facilities.  We have a right of first refusal to acquire the stock or assets of the corporation that manages the 54 self-storage facilities in Canada, if the Hughes Family or the corporation agrees to sell them.  We reinsure risks relating to loss of goods stored by customers in these facilities.  During each of the three month periods ended March 31, 2014 and 2013, we received $0.1 million in reinsurance premiums attributed to these facilities.  There is no assurance that these premiums will continue, as our rights to reinsure these risks may be qualified.

 

10.Share-Based Compensation

Under various share-based compensation plans and under terms established by a committee of our Board of Trustees, the Company grants non-qualified options to purchase the Company’s common shares, as well as restricted share units (“RSUs”), to trustees, officers, service providers and key employees.  

Stock options and RSUs are considered “granted” and “outstanding” as the terms are used herein, when i) the Company and the recipient reach a mutual understanding of the key terms of the award, ii) the award has been authorized, iii) the recipient is affected by changes in the market price of our stock, and iv) it is probable that any performance and service conditions will be met.  

We amortize the grant-date fair value of awards (net of anticipated forfeitures) as compensation expense over the service period.  The service period begins on the grant date and ends on the vesting date. For awards that are earned solely upon the passage of time and continued service, the entire cost of the award is amortized on a straight-line basis over the service period. For awards with performance conditions, the individual cost of each vesting is amortized separately over each individual service period (the “accelerated attribution” method).

Stock Options

Stock options vest over a three to five-year period, expire ten years after the grant date, and the exercise price is equal to the closing trading price of our common shares on the grant date.  Employees cannot require the Company to settle their award in cash.  We use the Black-Scholes option valuation model to estimate the fair value of our stock options. 

Outstanding stock option grants are included on a one-for-one basis in our diluted weighted average shares, to the extent dilutive, after applying the treasury stock method (based upon the average common share price during the period) to assumed exercise proceeds and measured but unrecognized compensation.

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For each of the three month periods ended March 31, 2014 and 2013, we recorded $0.7 million in compensation expense related to stock options.

During the three months ended March 31, 2014, 200,000 stock options were granted, 372,402 options were exercised and 2,000 options were forfeited.  A total of 1,999,809 stock options were outstanding at March 31, 2014 (2,174,211 at December 31, 2013).   

 

Restricted Share Units

RSUs generally vest ratably over a three to eight-year period from the grant date.  The grantee receives dividends for each outstanding RSU equal to the per-share dividends received by our common shareholders.  We expense any dividends previously paid upon forfeiture of the related RSU.  Upon vesting, the grantee receives common shares equal to the number of vested RSUs, less common shares withheld in exchange for tax deposits made by the Company to satisfy the grantee’s statutory tax liabilities arising from the vesting. 

The fair value of our RSUs is determined based upon the applicable closing trading price of our common shares.

During the three months ended March 31, 2014, 180,600 RSUs were granted, 22,813 RSUs were forfeited and 148,045 RSUs vested.  This vesting resulted in the issuance of 87,357 common shares.  In addition, tax deposits totaling $10.0 million were made on behalf of employees in exchange for 60,688 common shares withheld upon vesting. 

RSUs outstanding at March 31, 2014 and December 31, 2013 were 646,071 and 636,329, respectively.  A total of $5.6 million and $5.2 million in RSU expense was recorded for the three months ended March 31, 2014 and 2013, respectively, which include approximately $1.0 million and $0.8 million, respectively, in employer taxes incurred upon vesting.

See also “net income per common share” in Note 2 for further discussion regarding the impact of RSUs and stock options on our net income per common and income allocated to common shareholders.

11.Segment Information

Our reportable segments reflect the significant components of our operations that are evaluated separately by our chief operating decision maker (“CODM”) and have discrete financial information available.  We organize our segments based primarily upon the nature of the underlying products and services, and whether the operation is located in the U.S. or outside the U.S.  In making resource allocation decisions, our CODM considers the net income from continuing operations of each reportable segment included in the tables below, excluding the impact of depreciation and amortization, gains or losses on disposition of real estate facilities, and asset impairment charges.  The amounts for each reportable segment included in the tables below are in conformity with GAAP and our significant accounting policies as denoted in Note 2.  Ancillary revenues and expenses, interest and other income (other than from Shurgard Europe), interest expense, general and administrative expense and gains and losses on the early repayment of debt are not allocable to any of our reportable segments.  Our CODM does not consider the book value of assets in making resource allocation decisions.  

Following is the description of and basis for presentation for each of our segments.

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Domestic Self-Storage Segment

The Domestic Self-Storage Segment includes the operations of the 2,189 self-storage facilities owned by the Company and the Subsidiaries, as well as our equity share of the Other Investments.  For all periods presented, substantially all of our real estate facilities, goodwill and other intangible assets, other assets, and accrued and other liabilities are associated with the Domestic Self-Storage Segment.

European Self-Storage Segment

The European Self-Storage segment comprises our interest in Shurgard Europe, which has a separate management team reporting directly to our CODM and our joint venture partner.  The European Self-Storage segment includes our equity share of Shurgard Europe’s operations, the interest and other income received from Shurgard Europe, and foreign currency exchange gains and losses that are attributable to Shurgard Europe.  Our balance sheet includes an investment in Shurgard Europe (Note 4) and a loan receivable from Shurgard Europe (Note 5). 

Commercial Segment

The Commercial segment comprises our investment in PSB, a publicly-traded REIT with a separate management team that makes its financing, capital allocation and other significant decisions.  The Commercial segment also includes our direct interest in certain commercial facilities, substantially all of which are managed by PSB.  The Commercial segment presentation includes our equity earnings and interest income from PSB, as well as the revenues and expenses of our commercial facilities.  At March  31, 2014, the assets of the Commercial segment are comprised principally of our investment in PSB (Note 4).

Presentation of Segment Information

The following tables reconcile the performance of each segment, in terms of segment income, to our net income (amounts in thousands):

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12.Commitments and Contingencies

Contingent Losses

We are a party to various legal proceedings and subject to various claims and complaints; however, we believe that the likelihood of these contingencies resulting in a material loss to the Company, either individually or in the aggregate, is remote.

Insurance and Loss Exposure

We have historically carried customary property, earthquake, general liability, employee medical insurance and workers compensation coverage through internationally recognized insurance carriers, subject to customary levels of deductibles.  The aggregate limits on these policies of approximately $75 million for property losses and $102 million for general liability losses are higher than estimates of maximum probable losses that could occur from individual catastrophic events determined in recent engineering and actuarial studies; however, in case of multiple catastrophic events, these limits could be exhausted.  

We reinsure a program that provides insurance to our customers from an independent third-party insurer.  This program covers tenant claims for losses to goods stored at our facilities as a result of specific named perils (earthquakes are not covered by this program), up to a maximum limit of $5,000 per storage unit.  We reinsure all risks in this program, but purchase insurance from an independent third party insurance company for aggregate claims between $5.0 million and $15.0 million per occurrence.  We are subject to licensing requirements and regulations in several states.  At March 31, 2014, there were approximately 781,000 certificates held by our self-storage customers, representing aggregate coverage of approximately $1.8 billion.

 

 

13.Subsequent Events

On April 4, 2014, we acquired a self-storage facility in Austin, Texas, consisting of approximately 86,000 net rentable square feet, for $6.0 million in cash and loan assumption of $4.8 million.

On April 14, 2014, we issued an additional 2.0 million depository shares, representing 1/1,000 of a share of our Series Y Preferred Shares, at an issuance price of $25.00 per depository share, for a total of $50.0 million in gross proceeds. 

From April 1, 2014 through May 2, 2014, we repaid an additional $50.0 million on the Term Loan. 

As of May 2, 2014, we are under contract to acquire (subject to customary closing conditions) five self-storage facilities in North Carolina, with an aggregate of approximately 342,000 net rentable square feet, at a total cost of approximately $26.0 million in cash.