1.       Description of the Business

Public Storage, Inc., formerly a California corporation, was organized in 1980.   Effective June 1, 2007, following approval by our shareholders, we reorganized Public Storage, Inc. into Public Storage, a Maryland real estate investment trust (referred to herein as “the Company”, “the Trust”, “we”, “us”, or “our”).   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.   Our self-storage facilities are located primarily in the United States (“U.S.”).   We also have interests in self-storage facilities located in seven Western European countries.  

At June 30, 2009, we had direct and indirect equity interests in 2,010 self-storage facilities located in 38 states operating under the “Public Storage” name, and 185 self-storage facilities located in Europe which operate under the “Shurgard Storage Centers” name.   Included in the 2,010 self-storage facilities is one facility for which we discontinued operations during the three months ended June 30, 2009 in connection with an eminent domain proceeding.   We also have direct and indirect equity interests in approximately 21 million net rentable square feet of commercial space located in 11 states in the U.S. primarily operated by PS Business Parks, Inc. (“PSB”) under the “PS Business Parks” name.

Any reference to the number of properties, square footage, number of tenant reinsurance policies outstanding and the aggregate coverage of such 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.

2.       Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X.   Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.   In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair presentation have been reflected in these unaudited condensed consolidated financial statements.   Operating results for the three and six months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009 due to seasonality and other factors.   The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

Certain amounts previously reported in our December 31, 2008, March 31, 2008, and June 30, 2008 financial statements have been reclassified to conform to the June 30, 2009 presentation, including discontinued operations, the grouping of the separate captions “cumulative earnings” and “cumulative distributions” into “retained earnings (deficit)” on our condensed consolidated balance sheet, as well as reclassifications required by newly implemented accounting standards described below.  

The Company has evaluated subsequent events through August 7, 2009, which represents the filing date of this Form 10-Q with the Securities and Exchange Commission (“SEC”).   As of August 7, 2009, there were no subsequent events which required recognition or disclosure.

Adjustments due to accounting pronouncements becoming effective January 1, 2009

Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS No. 160”) and other accounting standards implemented by the Financial Accounting Standards Board and the SEC (collectively, the “Revised Minority Interest Standards”) became effective January 1, 2009.   As a result, we have reclassified certain equity interests previously referred to as minority interests on our balance sheet at December 31, 2008 to “permanent noncontrolling interests in subsidiaries” or “redeemable noncontrolling interests in subsidiaries.”   These reclassifications increased equity by $351,640,000, increased redeemable noncontrolling interests in subsidiaries by $12,777,000, and decreased minority interest by $364,417,000, as compared to the amounts previously presented as of December 31, 2008.   On our condensed consolidated statement of income, income allocations to the aforementioned equity interests were reclassified from “minority interest in income”, a reduction to income, to “income allocated to noncontrolling interests in subsidiaries,” an allocation of net income in calculating net income allocable to our common shareholders.   These adjustments increased net income $10,142,000 and $17,741,000 for the three and six months ended June 30, 2008, respectively, but had no impact upon net income allocable to our common shareholders or on earnings per common share, as compared to amounts previously presented.  

In addition, FASB Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” which became effective January 1, 2009, requires the “two class” method of allocating income with respect to restricted share units to determine basic and diluted earnings per common share.   Previously, restricted share units were included in weighted average diluted shares, based upon application of the treasury stock method.   This change resulted in a decrease in income allocable to our common shareholders of approximately $146,000 and $1,971,000 and a decrease in diluted weighted average common shares outstanding of 335,000 and 291,000 for the three and six months ended June 30, 2008, respectively.   As a result of these changes, basic and diluted earnings per common share each decreased approximately $0.01, as compared to amounts previously presented for the three and six months ended June 30, 2008, respectively.  

Consolidation Policy

Entities in which we have an interest are first evaluated to determine whether, in accordance with the provisions of the Financial Accounting Standards Board’s Interpretation No. 46R, “Consolidation of Variable Interest Entities,” they represent Variable Interest Entities (“VIE’s”).   VIE’s in which we are the primary beneficiary are consolidated.   Entities that are not VIE’s that we control are consolidated.  

When we are the general partner, we are considered to control the partnership unless the limited partners possess substantial “kick-out” or “participative” rights as defined in Emerging Issues Task Force Statement 04-5 – “Determining whether a general partner or the general partners as a group, controls a limited partnership or similar entity when the limited partners have certain rights” (“EITF 04-5”).  

The accounts of the entities we control, along with the accounts of the VIE’s for which we are the primary beneficiary, are included in our condensed consolidated financial statements, and all intercompany balances and transactions are eliminated.   We account for our investment in entities that we do not consolidate using the equity method of accounting or, if we do not have the ability to exercise significant influence over an investee, the cost method of accounting.   Changes in consolidation status are reflected effective the date the change of control or determination of primary beneficiary status occurred, and previously reported periods are not restated.   The entities that we consolidate during the periods, to which the reference applies, are referred to hereinafter as the “Consolidated Entities.”   The entities that we have an interest in but do not consolidate during the periods, to which the reference applies, are referred to hereinafter as the “Unconsolidated Entities.”  

Collectively, at June 30, 2009, the Company and the Consolidated Entities own a total of 2,000 real estate facilities, consisting of 1,991 self-storage facilities in the U.S., one self-storage facility in London, England and eight commercial facilities in the U.S.  

At June 30, 2009, the Unconsolidated Entities are comprised of PSB, Shurgard Europe, as well as various limited and joint venture partnerships (referred to as the “Other Investments”).   At June 30, 2009, PSB owns approximately 19.6 million rentable square feet of commercial space, Shurgard Europe has interests in 184 self-storage facilities in Europe with 9.8 million net rentable square feet, and the Other Investments own in aggregate 19 self-storage facilities in the U.S.  

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes.   Actual results could differ from those estimates.

Income Taxes

For all taxable years subsequent to 1980, the Company has qualified and intends to continue to qualify as a real estate investment trust (“REIT”), as defined in Section 856 of the Internal Revenue Code.   As a REIT, we do not incur federal or significant state tax on that portion of our taxable income which is distributed to our shareholders, provided that we meet certain tests.   We believe we have met these tests during 2008 and we expect to meet these tests during 2009 and, accordingly, no provision for federal income taxes has been made in the accompanying condensed consolidated financial statements on income produced and distributed on real estate rental operations.   Our taxable REIT subsidiaries are subject to regular corporate tax on their taxable income, and such corporate taxes are presented in ancillary cost of operations in our accompanying condensed consolidated statements of income.   We also are subject to certain state taxes, which are presented in general and administrative expense in our accompanying condensed consolidated statements of income.   We have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements with respect to all tax periods which remain subject to examination by major tax jurisdictions as of June 30, 2009, as well as the six month interim period ended June 30, 2009.

Real Estate Facilities

Real estate facilities are recorded at cost.   Costs associated with the acquisition, development, construction, renovation and improvement of properties are capitalized.   Interest, property taxes and other costs associated with development incurred during the construction period are capitalized as building cost.   Costs associated with the sale of real estate facilities or interests in real estate investments are expensed as incurred.   The purchase cost of existing self-storage facilities that we acquire are allocated based upon relative fair value of the land, building and tenant intangible components of the real estate facility.   Expenditures for repairs and maintenance are expensed when incurred.   Depreciation expense is computed using the straight-line method over the estimated useful lives of the buildings and improvements, which generally range from 5 to 25 years.

Other Assets

Other assets primarily consist of prepaid expenses, investments in held-to-maturity debt securities, accounts receivable, interest receivable, and restricted cash.  

Accrued and Other Liabilities

Accrued and other liabilities consist primarily of real property tax accruals, tenant prepayments of rents, accrued interest payable, losses and loss adjustment liabilities for our own exposures and estimated losses related to our tenant insurance activities, and trade payables.  

Financial Instruments

We have estimated the fair value of our financial instruments using available market information and appropriate valuation methodologies.   Considerable judgment is required in interpreting market data to develop estimates of market value.   Accordingly, estimated fair values are not necessarily indicative of the amounts that could be realized in current market exchanges.

For purposes of financial statement presentation, we consider all highly liquid financial instruments such as short-term treasury securities, money market funds with daily liquidity and a rating in excess of AAA by Standard and Poor’s, or investment grade short-term commercial paper with remaining   maturities of three months or less at the date of acquisition to be cash equivalents.   Any such cash and cash equivalents which are restricted from general corporate use (restricted cash) due to insurance or other regulations, or based upon contractual requirements, are included in other assets.  

Due to the short period to maturity and the underlying characteristics of our cash and cash equivalents, other assets, and accrued and other liabilities, we believe the carrying values as presented on the consolidated balance sheets are reasonable estimates of fair value.  

Financial assets that are exposed to credit risk consist primarily of cash and cash equivalents as well as accounts receivable and restricted cash which are included in other assets on our accompanying condensed consolidated balance sheets.   Cash and cash equivalents and restricted cash, consisting of short-term investments, including commercial paper, are only invested in investment instruments with an investment grade rating.   We have a loan receivable from Shurgard Europe.   See “Loan Receivable from Shurgard Europe” below for information regarding our fair value measurement of this instrument.  

At June 30, 2009, due primarily to our investment in and loan receivable from Shurgard Europe, our operations and our financial position are affected by fluctuations in the exchange rates between the Euro, and to a lesser extent, other European currencies, against the U.S. Dollar.

We estimate the fair value of our notes payable to be $529,532,000 at June 30, 2009, based upon discounting the future current cash flows under each respective note at an interest rate that approximates those of loans with similar credit characteristics, term to maturity and other market data.

Goodwill

Goodwill represents the excess of acquisition cost over the fair value of net tangible and identifiable intangible assets acquired in business combinations.   Each business combination from which our goodwill arose was for the acquisition of single businesses and accordingly, the allocation of our goodwill to our business segments is based directly on such acquisitions. Our goodwill has an indeterminate life.   Our goodwill balance of $174,634,000 is reported net of accumulated amortization of $85,085,000 as of June 30, 2009 and December 31, 2008 in our accompanying condensed consolidated balance sheets.

We evaluate impairment of goodwill annually by comparing the aggregate book value (including goodwill) of each reporting unit to their respective estimated fair value.   No impairment of our goodwill was identified in our annual evaluation at December 31, 2008.   No impairment indicators were noted as of June 30, 2009 which would have required an interim evaluation of goodwill for impairment.

Intangible Assets

We acquire finite-lived intangible assets representing primarily the estimated value of tenants in place (a “Tenant Intangible”) at the date of the acquisition of each respective acquired facility.   Tenant Intangibles are amortized relative to the benefit of the tenants in place to each period.   At June 30, 2009, our Tenant Intangibles have a net book value of $21,687,000 ($33,181,000 at December 31, 2008), which is net of accumulated amortization and impairment charges of $347,499,000 ($336,005,000 at December 31, 2008).  

Amortization expense of $1,032,000 and $11,722,000 was recorded for our Tenant Intangibles for the three months ended June 30, 2009 and 2008, respectively and $3,289,000 and $40,133,000 was recorded for the six months ended June 30, 2009 and 2008, respectively.   Also during the three and six months ended June 30, 2009, we recorded an impairment charge of $8,205,000 in connection with an eminent domain proceeding at one of our facilities.   This impairment charge is reflected under “discontinued operations” on our condensed consolidated statement of income.   The estimated future amortization expense for our finite-lived intangible assets is as follows:

  

  

We also have an intangible asset representing the value of the “Shurgard” trade name, which is used by Shurgard Europe pursuant to a licensing agreement described more fully in Note 3, with a book value of $18,824,000 at June 30, 2009 and December 31, 2008.   The Shurgard trade name has an indefinite life and, accordingly, we do not amortize this asset but instead analyze it on an annual basis for impairment.   No impairments were noted from our evaluations in any periods presented in these accompanying condensed consolidated financial statements.

Evaluation of Asset Impairment

We evaluate our real estate and Tenant Intangibles for impairment on a quarterly basis.   We first evaluate these assets for indicators of impairment, and if any indicators of impairment are noted, we determine whether the carrying value of such assets is in excess of the future estimated undiscounted cash flows attributable to these assets.   If there is excess carrying value over such future undiscounted cash flows, an impairment charge is booked for the excess of carrying value over the assets’ estimated fair value.   Any long-lived assets which we expect to sell or otherwise dispose of prior to their estimated useful life are stated at the lower of their estimated net realizable value (less cost to sell) or their carrying value.   No impairment was identified from our evaluations in any periods presented in the accompanying condensed consolidated financial statements, other than the impairment totaling $8,205,000 described above with respect to intangible assets recorded in the three months ended June 30, 2009.  

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 are recognized as a reduction to rental income over the promotional period, which is generally during the first month of occupancy.   Ancillary revenues and interest and other income is recognized when earned.   Equity in earnings of real estate entities is recognized based on our ownership interest in the earnings of each of the Unconsolidated Entities.  

We accrue for property tax expense based upon actual amounts billed for the related time periods and, in some circumstances due to taxing authority assessment timing and disputes of assessed amounts, estimates and historical trends.   If these estimates are incorrect, the timing and amount of expense recognition could be affected.   Cost of operations, general and administrative expense, interest expense, as well as television, yellow page, and other advertising expenditures are expensed as incurred.   Casualty losses or gains are recognized in the period the casualty occurs, based upon the differential between the book value of assets destroyed and estimated insurance proceeds, if any, that we expect to receive in accordance with our insurance contracts.  

Foreign Currency Exchange Translation

The local currency is the functional currency for the foreign operations for which we have an interest.   Assets and liabilities included on our condensed consolidated balance sheets, including our equity investment in Shurgard Europe, are translated at end-of-period exchange rates, while revenues, expenses, and equity in earnings of the related real estate entities, are translated at the average exchange rates in effect during the period.   The Euro, which represents the functional currency used by a majority of the foreign operations for which we have an interest, was translated at an end-of-period exchange rate of approximately 1.405 U.S. Dollars per Euro at June 30, 2009 (1.409 at December 31, 2008), and average exchange rates of 1.361 and 1.563 for the three months ended June 30, 2009 and 2008, respectively and 1.334 and 1.530 for the six months ended June 30, 2009 and 2008, respectively.   Equity is translated at historical rates and the resulting cumulative translation adjustments, to the extent not included in net income, are included as a component of accumulated other comprehensive income (loss) until the translation adjustments are realized.   See “Other Comprehensive Income” below for further information regarding our foreign currency translation gains and losses.  

Fair Value Accounting

In 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (“SFAS No. 157”).   SFAS No. 157 expands required fair value disclosures, whenever other accounting standards require or permit fair value measurements, including the information used to measure fair value, and the effect of fair value measurements on earnings.   SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, and establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.   The Company adopted the provisions of SFAS No. 157 on January 1, 2008 with respect to financial assets and liabilities and on January 1, 2009 with respect to non-financial assets and liabilities, which had no effect on our financial position, operating results or cash flows.   See “Loan Receivable from Shurgard Europe” and “Financial Instruments”, as well as “Redeemable Noncontrolling Interests in Subsidiaries” and “Other Permanent Noncontrolling Interests in Subsidiaries” in Note 7 for information regarding our fair value measurements.

Loan Receivable from Shurgard Europe

As of June 30, 2009, we had a loan receivable from Shurgard Europe totaling $550,499,000 ($552,361,000 at December 31, 2008).

  

The loan bears interest at a fixed rate of 7.5% per annum, and had an initial term of one year expiring March 31, 2009 which was extended by Shurgard Europe pursuant to the terms of the original note to March 31, 2010.   If Shurgard Europe acquires its partner’s interests in First Shurgard and Second Shurgard (collectively, the “Existing European Joint Ventures”), we have agreed to provide additional loans to Shurgard Europe, under the same terms as the existing loans, for up to €185 million ($259.9 million as of June 30, 2009).   This commitment was also extended to March 31, 2010 and was originally for €305 million, but was reduced as the result of refinancing one of the joint venture loans.   Shurgard Europe has no obligation to acquire these interests, and the acquisition of these interests is contingent on a number of items, including whether we assent to the acquisition.   Loan fees collected from Shurgard Europe are amortized on a straight-line basis as interest income over the applicable term to which the fee applies.

The loan receivable from Shurgard Europe is denominated in Euros and is converted to U.S. Dollars for financial statement purposes.   During each applicable period, because we expected repayment within two years of each respective balance sheet date, we have been recognizing foreign exchange rate gains or losses in income as a result of changes in exchange rates between the Euro and the U.S. Dollar during the three and six months ended June 30, 2009 and 2008.   For the three and six months ended June 30, 2009, we recorded interest income of approximately $5,797,000 and $10,974,000, respectively, related to the loan. For the three and six months ended June 30, 2008, we recorded interest income of approximately $6,319,000 related to the loan.

The $5,797,000 in interest income for the three months ended June 30, 2009 reflects the gross amount charged to Shurgard Europe totaling $11,366,000 less our 49% pro-rata portion totaling $5,569,000 which is reflected as part of our equity in earnings of real estate entities rather than interest and other income.   The $10,974,000 in interest income for the six months ended June 30, 2009 reflects the gross amount charged to Shurgard Europe totaling $21,517,000 less our 49% pro-rata portion totaling $10,543,000 which is reflected as part of our equity in earnings of real estate entities rather than interest and other income.   The $6,319,000 in interest income for the three and six months ended June 30, 2008 reflects the gross amount charged to Shurgard Europe totaling $12,390,000 less our 49% pro-rata portion totaling $6,071,000 which is reflected as equity in earnings of real estate entities rather than interest and other income.  

Although there can be no assurance, we believe that Shurgard Europe has sufficient liquidity and collateral, and we have sufficient creditor rights, such that credit risk is minimal.   In addition, we believe the interest rate on the loan approximates the market rate for loans with similar credit characteristics and tenor; however, due to dysfunctions in current credit markets, it is difficult to estimate a market rate.   Nonetheless, based upon the estimated market rate combined with the short term to maturity, we believe the carrying value of the loan approximates fair value. The characteristics of the loan and comparative metrics utilized in our evaluation represent significant unobservable inputs, which are “Level 3” inputs as the term is utilized in SFAS No. 157.

Other Comprehensive Income

We reflect other comprehensive income (loss) for our pro-rata share of currency translation adjustments related to the foreign operations for which we have an interest that is not already recognized in our net income.   Such other comprehensive income (loss) is reflected as a direct adjustment to “Accumulated Other Comprehensive Income” in the equity section of our consolidated balance sheet, and is added to our net income in determining total comprehensive income for the period.  

  

The following table reflects the components of our other comprehensive (loss) income, and our total comprehensive income, for each respective period:    

  

  

	For the Three Months Ended June 30,		For the Six Months Ended June 30,
	2009	2008	2009	2008
	(Amounts in thousands)
Net income..........................................................	$     205,387	$     143,955	$    358,816	$     663,896
Other comprehensive income (loss):
Aggregate foreign currency translation adjustments for the period.........................	57,249	(947)	12,313	65,275
Less: foreign currency translation adjustments recognized during the period and reflected in “Gain (loss) on disposition of real estate investments”....................................	-	-	-	(37,854)
Less: foreign currency translation adjustments reflected in net income as “Foreign currency (gain) loss”.................................	(33,205)	2	1,528	(40,969)
Other comprehensive income (loss) income for the period..................................................	24,044	(945)	13,841	(13,548)
Total comprehensive income...............................	$     229,431	$     143,010	$    372,657	$     650,348

  

  

Discontinued Operations

We segregate all of our discontinued operations that can be distinguished from the rest of the Company and will be eliminated from the ongoing operations of the Company.   During the six months ended June 30, 2009, we decided to terminate our truck rental and containerized storage business units.   Truck operations ceased as of March 31, 2009, and the containerized operations are being actively marketed for sale and are expected to be disposed of by December 31, 2009. As a result, we reclassified all of the historical revenues and expenses of these operations from ancillary revenues and ancillary expenses, into “discontinued operations.”   Included in discontinued operations is $3.5 million in expenses incurred in the six months ended June 30, 2009 related primarily to disposing of trucks used in our truck rental operations.   Also included in discontinued operations for the three and six months ended June 30, 2009 is an $8.2 million impairment charge on intangible assets in connection with an eminent domain proceeding at one of our self-storage facilities.  

Net Income per Common Share

In computing net income allocated to our common shareholders, we first allocate net income to our noncontrolling interests in subsidiaries (Note 7) and preferred shareholders to arrive at net income allocable to our common shareholders.   Net income allocated to preferred shareholders or noncontrolling interests in subsidiaries includes any excess of the cash required to redeem any preferred securities in the period over the net proceeds from the original issuance of the securities (or, if securities are redeemed for less than the original issuance proceeds, income allocated to the holders of the redeemed securities is reduced).  

The remaining net income is allocated among our regular common shares, restricted share units, and our Equity Shares, Series A based upon the dividends declared (or accumulated) for each security in the period, combined with each security’s participation rights in undistributed earnings.  

Net income allocated to our regular common shares from continuing operations is computed by eliminating the net income or loss from discontinued operations allocable to our regular common shares, from net income allocated to our regular common shares.

Basic net income per share, basic net income (loss) from discontinued operations per share, and basic net income from continuing operations per share are computed using the weighted average common shares outstanding.   Diluted net income per share, diluted net income (loss) from discontinued operations per share, and diluted net income from continuing operations per share are computed using the weighted average common shares outstanding, adjusted for the impact, if dilutive, of stock options outstanding (Note 10).   Diluted net loss per share from discontinued operations does not include the impact of stock options outstanding, because including stock options would be anti-dilutive when applied to the loss on discontinued operations for each period presented.  

The following table reflects the components of the calculations of our basic and diluted net income per share, basic and diluted net income (loss) from discontinued operations per share, and basic and diluted net income from continuing operations per share which are not already otherwise set forth on the face of our condensed consolidated statements of income: 

  

Recent Accounting Pronouncements and Guidance

Codification and Hierarchy of GAAP

In June 2009, the Financial Accounting Standards Board (the “FASB”) issued SFAS 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162.”   SFAS 168 established the effective date for use of the FASB codification for interim and annual periods ending after September 15, 2009.   Companies should account for the adoption of the guidance on a prospective basis.   We do not anticipate the adoption of SFAS 168 will have a material impact on our financial statements.   We will update our disclosures for the appropriate FASB codification references after adoption, in the third quarter of 2009.

  

Accounting for Transfers of Financial Assets

  

In June 2009, the FASB also issued SFAS 167 “Amendments to FASB Interpretation No. 46”, and SFAS 166 “Accounting for Transfers of Financial Assets - an Amendment of FASB Statement No. 140.”   SFAS 167 amends the existing guidance around FIN 46(R), to address the elimination of the concept of a qualifying special purpose entity.   Also, it replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity.   Additionally, SFAS 167 provides for additional disclosures about an enterprise’s involvement with a variable interest entity.   SFAS 166 amends SFAS 140 to eliminate the concept of a qualifying special purpose entity, amends the derecognition criteria for a transfer to be accounted for as a sale under SFAS 140, and will require additional disclosure over transfers accounted for as a sale.   The effective date for both pronouncements is for the first fiscal year beginning after November 15, 2009, and will require retrospective application.   We are still assessing the potential impact of adopting these two statements.

3.     Disposition of an Interest in Shurgard Europe

On March 31, 2008, an institutional investor acquired a 51% interest in Shurgard European Holdings LLC, a newly formed Delaware limited liability company and the holding company for Shurgard Europe (“Shurgard Holdings”).   Public Storage owns the remaining 49% interest and is the managing member of Shurgard Holdings.

Our net proceeds from the transaction aggregated $609,059,000, comprised of $613,201,000 paid by the institutional investor less $4,142,000 in legal, accounting, and other expenses incurred in connection with the transaction.   As a result of the disposition, we reduced our investment in Shurgard Europe by approximately $305,048,000 for the pro rata portion of our March 31, 2008 investment that was sold, and recognized a gain of $304,011,000 upon disposition, representing the difference between the net proceeds received of $609,059,000 and the pro rata portion of our investment sold of $305,048,000.

In addition, as a result of our disposition of this interest, a portion of the cumulative currency exchange gains we had previously recognized in Other Comprehensive Income with respect to Shurgard Europe was realized.   Accordingly, we recognized a cumulative currency exchange gain of $37,854,000, representing 51% (the pro rata portion of Shurgard Europe that was sold) of the cumulative currency exchange gain previously included in Other Comprehensive Income.  

The gain upon disposition of $304,011,000 and associated realized currency exchange gain totaling $37,854,000 are both included in the line-item “gain (loss) on disposition of real estate investments” in our condensed consolidated statement of income for the six months ended June 30, 2008.

The results of operations of Shurgard Europe have been included in our condensed consolidated statements of income for the three months ended March 31, 2008.   Commencing with the quarter beginning April 1, 2008, our pro rata share of operations of Shurgard Europe is reflected on our condensed consolidated statement of income under equity in earnings of real estate entities.

4.             Real Estate Facilities

Activity in real estate facilities is as follows: 

  

During the six months ended June 30, 2009, we completed various expansion projects with total costs of $13,570,000.   We also sold an existing real estate facility as well as a portion of certain real estate facilities during the six months ended June 30, 2009, primarily in connection with condemnation proceedings, for aggregate proceeds totaling $10,261,000.   We recorded an aggregate gain of approximately $6,903,000, of which $4,181,000 is included in discontinued operations and $2,722,000 is included in “gain (loss) on disposition of real estate investments.”

Construction in process at June 30, 2009 includes the development costs relating to various expansions to existing self-storage facilities.

5.     Investments in Real Estate Entities

During the three and six months ended June 30, 2009, we recognized earnings from our investments in real estate entities of $7,398,000, and $30,209,000, respectively, and received cash distributions from such investments, totaling $11,889,000, and $23,708,000, respectively.   During the three and six months ended June 30, 2008, we recognized earnings from our investments in real estate entities of $4,632,000, and $7,361,000, respectively, and received cash distributions from such investments, totaling $12,656,000, and $19,149,000, respectively.   Included in earnings recognized for the six months ended June 30, 2009 is $16,284,000, representing our share of the earnings allocated from PSB’s preferred shareholders, as a result of PSB’s repurchases of preferred stock and preferred units for amounts that were less than the related book value, during the period.

During the six months ended June 30, 2009 and 2008, in addition to the impact of earnings recognized and cash distributions received, our investments in real estate entities increased by $11,633,000 and decreased by $891,000, respectively, due to foreign currency translation adjustments.  

The following table sets forth our investments in the real estate entities at June 30, 2009 and December 31, 2008, and our equity in earnings of real estate entities for the three and six months ended June 30, 2009 and 2008 (amounts in thousands):

  

  

Investment in PSB

PSB is a REIT traded on the New York Stock Exchange, which controls an operating partnership (collectively, the REIT and the operating partnership are referred to as “PSB”).   At June 30, 2009, PSB owned and operated approximately 19.6 million net rentable square feet of commercial space and manages certain of our commercial space.

We have a 46% common equity interest in PSB as of June 30, 2009 and December 31, 2008, comprised of our ownership of 5,418,273 shares of PSB’s common stock and 7,305,355 limited partnership units in the operating partnership.   The limited partnership 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 June 30, 2009 ($48.44 per share of PSB common stock), the shares and units had a market value of approximately $616.3 million as compared to a book value of $280.1 million.

The following table sets forth selected financial information of PSB; the amounts represent 100% of PSB’s balances and not our pro-rata share.

  

  

Investment in Shurgard Europe

At June 30, 2009 we had a 49% equity investment in Shurgard Europe.   As a result of our disposition of an interest in Shurgard Europe, we deconsolidated Shurgard Europe effective March 31, 2008 (see Note 3).  

For the three and six months ended June 30, 2009, we recorded an aggregate of $1,709,000 and $3,608,000, respectively, in equity in earnings of real estate entities with respect to our investment in Shurgard Europe.   For the three and six months ended June 30, 2008, we recorded an aggregate of $1,457,000 in equity in earnings of real estate entities with respect to our investment in Shurgard Europe.   During the six months ended June 30, 2009 and 2008, our investment in Shurgard Europe increased by approximately $11,633,000 and decreased by $891,000, respectively, due to the impact of changes in foreign currency exchange rates, primarily between the Euro and the U.S. Dollar.

The following table sets forth selected financial information of Shurgard Europe.   These amounts are based upon 100% of Shurgard Europe’s balances, rather than our pro rata share and are based upon Public Storage’s historical acquired book basis.  

Amounts for all periods are presented, notwithstanding that Shurgard Europe was deconsolidated effective March 31, 2008.   Accordingly, all amounts (net of intercompany eliminations) prior to April 1, 2008 are included in our consolidated financial statements.

  

(a)      Approximately $764,000 in net income and $1,636,000 in net loss was allocated to permanent noncontrolling equity interests in subsidiaries for the three months ended June 30, 2009 and 2008, respectively, of which $2,858,000 and $3,448,000, respectively, represented depreciation and amortization expense.   During the six months ended June 30, 2009 and 2008, approximately $178,000 in net income and $3,778,000 in net loss, respectively, was allocated to permanent noncontrolling equity interests in subsidiaries, of which $5,597,000 and $6,632,000, respectively, represented depreciation and amortization expense.

  

  

  

Our equity in earnings of Shurgard Europe for the three and six months ended June 30, 2009 and the six months ended June 30, 2008 totaling $1,709,000, $3,608,000 and $1,457,000, respectively, are comprised of (i) losses of $4,049,000, $7,300,000 and $4,819,000, respectively, representing our 49% pro-rata share of Shurgard Europe’s net loss for the respective periods and (ii) income of $5,758,000, $10,908,000, and $6,276,000, respectively, representing our 49% pro-rata share of the interest income and trademark license fees received from Shurgard Europe for the respective periods (such amounts are presented as equity in earnings of real estate entities rather than interest and other income).     

Other Investments

At June 30, 2009, other investments include an aggregate common equity ownership of approximately 24% in entities that collectively own 19 self-storage facilities.  

The following table sets forth certain condensed financial information (representing 100% of these entities’ balances and not our pro-rata share) with respect to the 19 facilities that we have an interest in at June 30, 2009:

  

  

6.     Notes Payable and Line of Credit

The carrying amounts of our notes payable at June 30, 2009 and December 31, 2008 consist of the following (dollar amounts in thousands):

  

  

When assumed in connection with property or other acquisitions, notes payable are recorded at their respective estimated fair values upon acquisition.   Any initial premium or discount, representing the difference between the stated note rate and estimated fair value on the respective date of assumption, is amortized over the remaining term of the notes using the effective interest method.   Fair values are determined based upon discounting the future cash flows under each respective note at an interest rate that approximates those of loans with similar credit characteristics, term to maturity, and other market data which represent significant unobservable inputs, which are “Level 3” inputs as the term is utilized in SFAS No. 157.

At June 30, 2009, we have a revolving credit agreement (the “Credit Agreement”) which expires on March 27, 2012, with an aggregate limit with respect to borrowings and letters of credit of $300 million.   Amounts drawn on the Credit Agreement bear an annual interest rate ranging from the London Interbank Offered Rate (“LIBOR”) plus 0.35% to LIBOR plus 1.00% depending on our credit ratings (LIBOR plus 0.35% at June 30, 2009).   In addition, we are required to pay a quarterly facility fee ranging from 0.10% per annum to 0.25% per annum depending on our credit ratings (0.10% per annum at June 30, 2009).   We had no outstanding borrowings on our Credit Agreement at June 30, 2009 or at August 7, 2009.   At June 30, 2009, we had undrawn standby letters of credit, which reduce our borrowing capability with respect to our line of credit by the amount of the letters of credit, totaling $20,000,000 ($17,736,000 at December 31, 2008).  

On February 12, 2009, we acquired $110,223,000 face amount ($113,736,000 book value) of our existing unsecured notes pursuant to a tender offer for an aggregate of $109,622,000 in cash (including costs associated with the tender of $414,000) plus accrued interest.   In connection with this transaction, we recognized a gain of $4,114,000 for the six months ended June 30, 2009, representing the difference between the book value of $113,736,000 and the retirement amount paid plus tender offer costs.

Our notes payable and our Credit Agreement each have various customary restrictive covenants, all of which have been met at June 30, 2009.  

At June 30, 2009, approximate principal maturities of our notes payable are as follows (amounts in thousands):

We incurred interest expense (including interest capitalized as real estate totaling $347,000 and $1,182,000, respectively for the six months ended June 30, 2009 and 2008) with respect to our notes payable, capital leases, debt to joint venture partner and line of credit aggregating $15,763,000 and $27,270,000 for the six months ended June 30, 2009 and 2008, respectively.   These amounts were comprised of $17,652,000 and $29,704,000 in cash paid for the six months ended June 30, 2009 and 2008, respectively, less $1,889,000 and $2,434,000 in amortization of premium, respectively.

7.     Noncontrolling Interests in Subsidiaries

In consolidation, we classify ownership interests in the net assets of each of the Consolidated Entities, other than our own, as “noncontrolling interests in subsidiaries.”   If these interests have the ability to require us, except in the circumstances of an entity liquidation, to redeem the underlying securities for cash, assets, or other securities that would not also be classified as equity, then such interests are presented on our balance sheet outside of equity.   At the end of each reporting period, if the book value is less than the estimated amount to be paid upon a redemption occurring on the related balance sheet date, with the offset against retained earnings.   All other noncontrolling interests in subsidiaries are presented as a component of equity, “permanent noncontrolling interests in subsidiaries.”

Redeemable Noncontrolling Interests in Subsidiaries

At June 30, 2009, the Other Redeemable Noncontrolling Interests in Subsidiaries represent equity interests in three entities that own in aggregate 14 self-storage facilities.   At December 31, 2008, these interests were increased and retained earnings (deficit) was decreased by a total of $6,469,000 in connection with the implementation of SFAS No. 160, to adjust to their estimated liquidation value (which approximates fair value).   We estimate the amount to be paid upon redemption of these interests by applying the related provisions of the governing documents to our estimate of the fair value of the underlying net assets (principally real estate assets).

In 2007, we sold an approximately 0.6% common equity interest in Shurgard Europe to various officers of the Company (the “PS Officers”), other than our chief executive officer.   For periods commencing from the sale of the interest through March 31, 2008, the PS Officers’ were allocated their pro rata share of the earnings of Shurgard Europe, and this was included in “Other Redeemable noncontrolling interests in subsidiaries.”   As described in Note 3, on March 31, 2008, we deconsolidated Shurgard Europe and, as a result, noncontrolling interests in subsidiaries with respect to the PS Officers’ investment was eliminated.   See Note 5 under “Investment in Shurgard Europe” for further historical information regarding Shurgard Europe.  

During the three and six months ended June 30, 2009, we allocated a total of $244,000 and $506,000, respectively, in income to these interests.   During the same periods in 2008, we allocated a total of $274,000 and $513,000, respectively, of income to these interests.   During the six months ended June 30, 2009, these interests were increased by $255,000 to adjust to their estimated liquidation value (which approximates fair value).   During the six months ended June 30, 2009 and 2008, we paid distributions to these interests totaling $666,000 and $645,000, respectively.

Permanent Noncontrolling Interests in Subsidiaries

At June 30, 2009, the Other Permanent Noncontrolling Interests in Subsidiaries represent equity interests in 28 entities that own an aggregate of 94 self-storage facilities (the “Other Permanent Noncontrolling Interests in Subsidiaries”) and our various preferred partnership units (the “Preferred Partnership Interests”).   These interests are presented as equity because the holders of the interests do not have the ability to require us to redeem them for cash or other assets, or other securities that would not also be classified as equity.      

Preferred Partnership Interests

At December 31, 2008, our preferred partnership units outstanding were comprised of 8,000,000 units of our 6.400% Series NN ($200,000,000 carrying amount, redeemable March 17, 2010), 1,000,000 units of our 6.250% Series Z ($25,000,000 carrying amount, redeemable October 12, 2009), and 4,000,000 units of our 7.250% Series J ($100,000,000 carrying amount, redeemable May 9, 2011) preferred partnership units.  

In March 2009, we acquired all of the 6.40% Series NN preferred partnership units from a third party ($200.0 million carrying amount) for approximately $128.0 million, plus accrued and unpaid distributions from December 31, 2008 through the closing date.   This transaction resulted in an increase in paid-in capital of approximately $72.0 million for the six months ended June 30, 2009, based upon the excess of the carrying amount over the amount paid.  

Also in March 2009, we acquired all of the 6.25% Series Z preferred partnership units from a third party ($25.0 million carrying amount) for $25.0 million.   This resulted in no increase in income allocated to the common shareholders as they were acquired at par.  

At June 30, 2009, our preferred partnership units outstanding were comprised of 4,000,000 units of our 7.250% Series J preferred units ($100,000,000 carrying amount, redeemable May 9, 2011).   Subject to certain conditions, the Series J preferred units are convertible into our 7.25% Series J Cumulative Preferred Shares.  

During the three and six months ended June 30, 2009, we allocated a total of $1,813,000 and $5,830,000, respectively, in income to these interests based upon distributions paid.   During the same periods in 2008, we allocated a total of $5,403,000 and $10,806,000, respectively, in income to these interests based upon distributions paid.  

In addition, during the six months ended June 30, 2009, we allocated $72,000,000 in income from these interests in determining net income allocable to Public Storage shareholders based upon our redemption of certain of the preferred partnership units for a cash payment that was $72,000,000 less than the related book value.   

Other Permanent Noncontrolling Interests in Subsidiaries

  

At June 30, 2009, the Other Permanent Noncontrolling Interests in Subsidiaries represent equity interests in 28 entities (generally partnerships) that own in aggregate 94 self-storage facilities.   

Shurgard Europe has a 20% equity interest in two VIE’s which developed self-storage facilities in Europe, and Shurgard Europe was the primary beneficiary.   The remaining 80% equity interest in these entities is owned by an unaffiliated investor.   On March 31, 2008, Shurgard Europe was deconsolidated (see Note 3), eliminating these permanent noncontrolling interests in subsidiaries at March 31, 2008.   See Note 5 under “Investment in Shurgard Europe” for further historical information regarding Shurgard Europe, including historical income allocated to these interests.   Earnings allocated to these interests are included in “Other Permanent Noncontrolling Interests in Subsidiaries” for periods prior to the deconsolidation of Shurgard Europe.

During the three and six months ended June 30, 2009, we allocated a total of $4,158,000 and $8,306,000, respectively, in income to these interests.   During the same periods in 2008, we allocated a total of $4,465,000 and $6,422,000, respectively, of income to these interests.   During the six months ended June 30, 2009 and 2008, we paid distributions to these interests totaling $7,581,000 and $7,950,000, respectively.  

8.     Public Storage Shareholders’ Equity

Cumulative Preferred Shares

At June 30, 2009 and December 31, 2008, we had the following series of Cumulative Preferred Shares of beneficial interest outstanding: 

  

The holders of our Cumulative Preferred Shares have general preference rights with respect to liquidation and quarterly distributions.   Holders of the preferred shares, except under certain conditions and as noted below, 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 events of default have been cured.   At June 30, 2009, there were no dividends in arrears.

Except under certain conditions relating to the Company’s qualification as a REIT, the Cumulative Preferred Shares are not redeemable prior the dates indicated on the table above.   On or after the respective dates, each of the series of Cumulative Preferred Shares will be redeemable, at the option of the Company, in whole or in part, at $25.00 per share (or depositary share as the case may be), plus accrued and unpaid dividends.   Holders of the Cumulative Preferred Shares do not have the right to require the Company to redeem such shares.

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

During March 2009, we repurchased certain of our Cumulative Preferred Shares in privately negotiated transactions as follows: Series V – 700,000 depositary shares, each representing 1/1,000 of a share of our Cumulative Preferred Shares at a total cost of $13,230,000, Series C – 175,000 depositary shares, each representing 1/1,000 of a share of our Cumulative Preferred Shares at a total cost of $2,695,000 and Series F – 107,000 depositary shares, each representing 1/1,000 of a share of our Cumulative Preferred Shares at a total cost of $1,610,000.   The carrying value of the shares repurchased totaled $23.8 million ($24.6 million liquidation preference less $0.8 million of original issuance costs), and exceeded the aggregate repurchase cost of $17.5 million by approximately $6.2 million.   For purposes of determining net income per share, income allocated to our preferred shareholders was reduced by the $6.2 million for the six months ended June 30, 2009.

Common Shares

Common Shares

During the six months ended June 30, 2009, we issued 75,971 common shares in connection with employee stock-based compensation.  

Our Board of Trustees previously authorized the repurchase from time to time of up to 25,000,000 of our common shares on the open market or in privately negotiated transactions.   On May 8, 2008, such authorization was increased to 35,000,000 common shares.   During the six months ended June 30, 2009, we did not repurchase any of our common shares.   Through June 30, 2009, we have repurchased a total of 23,721,916 of our common shares pursuant to this authorization.

Equity Shares, Series A

At June 30, 2009 and December 31, 2008, we had 8,377,193 of depositary shares outstanding, each representing 1/1,000 of an Equity Share, Series A.   The Equity Shares, Series A rank on parity with our common shares and junior to the Cumulative Preferred Shares with respect to general preference rights and have a liquidation amount which cannot exceed $24.50 per share.   Distributions with respect to each depositary share shall be the lesser of:   (i) five times the per share dividend on our common shares or (ii) $2.45 per annum.   We have no obligation to pay distributions on the depositary shares if no distributions are paid to common shareholders.   During the six months ended June 30, 2009 and 2008, we paid quarterly distributions to the holders of the Equity Shares, Series A of $0.6125 per share for each of the quarters ended March 31 and June 30.

Except in order to preserve the Company’s Federal income tax status as a REIT, we may not redeem the depositary shares representing the Equity Shares, Series A before March 31, 2010.   On or after March 31, 2010, we may, at our option, redeem the depositary shares at $24.50 per depositary share.   If the Company fails to preserve its Federal income tax status as a REIT, each of the depositary shares will be convertible at the option of the shareholder into .956 common shares.   The depositary shares are otherwise not convertible into common shares.   Holders of depositary shares vote as a single class with holders of our common shares on shareholder matters, but the depositary shares have the equivalent of one-tenth of a vote per depositary share.

Equity Shares, Series AAA

In November 1999, we sold $100,000,000 (4,289,544 shares) of Equity Shares, Series AAA (“Equity Shares AAA”) to a newly formed joint venture.   The Equity Shares AAA ranks on a parity with common shares and junior to the Senior Preferred Shares with respect to general preference rights, and has a liquidation amount equal to 120% of the amount distributed to each common share.   Annual distributions per share are equal to the lesser of (i) five times the amount paid per common share or (ii) $2.1564. We have no obligation to pay distributions if no distributions are paid to common shareholders.   During the six months ended June 30, 2009 and 2008, we paid quarterly distributions to the holder of the Equity Shares, Series AAA of $0.5391 per share for each of the quarters ended March 31 and June 30.   For all periods presented, the Equity Shares, Series AAA and related dividends are eliminated in consolidation.

  

Dividends

  

The unaudited characterization of dividends for Federal income tax purposes is made based upon earnings and profits of the Company, as defined by the Internal Revenue Code.   Common share dividends totaled $92.9 million ($0.55 per share) and $92.8 million ($0.55 per share), for the three months ended June 30, 2009 and 2008, respectively, and $185.8 million ($1.10 per share) and $185.6 million ($1.10 per share), for the six months ended June 30, 2009 and 2008, respectively.   Equity Shares, Series A dividends totaled $5.1 million ($0.6125 per share) and $5.3 million ($0.6125 per share), for the three months ended June 30, 2009 and 2008, respectively, and totaled $10.3 million ($1.225 per share) and $10.7 million ($1.225 per share), for the six months ended June 30, 2009 and 2008, respectively.   Preferred share dividends pay fixed rates from 6.125% to 7.500% with a total liquidation amount of $3,399,777,000 at June 30, 2009 ($3,424,327,000 at December 31, 2008) and dividends aggregating $58.1 million and $60.3 million for the three months ended June 30, 2009 and 2008, respectively, and $116.2 million and $120.7 million for the six months ended June 30, 2009 and 2008, respectively.  

9.             Related Party Transactions

Mr. Hughes, Public Storage’s Chairman of the Board of Trustees, and his family (collectively the “Hughes Family”) have ownership interests in, and operate approximately 51 self-storage facilities in Canada using the “Public Storage” brand name (“PS Canada”) pursuant to a royalty-free trademark license agreement with Public Storage.   We currently do not own any interests in these facilities nor do we own any facilities in Canada.   The Hughes Family owns approximately 20% of our common shares outstanding at June 30, 2009.   We have a right of first refusal to acquire the stock or assets of the corporation that manages the 51 self-storage facilities in Canada, if the Hughes Family or the corporation agrees to sell them.   However, we have no interest in the operations of this corporation, we have no right to acquire this stock or assets unless the Hughes Family decides to sell and we receive no benefit from the profits and increases in value of the Canadian self-storage facilities.

We reinsure risks relating to loss of goods stored by tenants in the self-storage facilities in Canada.   During the six months ended June 30, 2009 and 2008, we received $390,000 and $441,000, respectively, in reinsurance premiums attributable to the Canadian facilities.   Since our right to provide tenant reinsurance to the Canadian facilities may be qualified, there is no assurance that these premiums will continue.

Public Storage and Mr. Hughes are co-general partners in certain consolidated partnerships and affiliated partnerships of Public Storage that are not consolidated.   The Hughes Family owns 47.9% of the voting stock and Public Storage holds 46% of the voting and 100% of the nonvoting stock (representing substantially all the economic interest) of a private REIT.   The private REIT owns limited partnership interests in five affiliated partnerships.   The Hughes Family also owns limited partnership interests in certain of these partnerships and holds securities in PSB.   PS Canada holds approximately a 1.2% interest in Stor-RE, a consolidated entity that provides liability and casualty insurance for PS Canada, Public Storage and certain affiliates of Public Storage, for occurrences prior to April 1, 2004 as described below.   Public Storage and the Hughes Family receive distributions from these entities in accordance with the terms of the partnership agreements or other organizational documents.

From time to time, the Company and the Hughes Family have acquired limited partnership units from limited partners of the Company’s consolidated partnerships.   In connection with the acquisition in 1998 and 1999 of a total of 638 limited partnership units by Tamara Hughes Gustavson and H-G Family Corp., a company owned by Hughes Family members, the Company was granted an option to acquire the limited partnership units acquired at cost, plus expenses.   During the fourth quarter of 2008, the Company exercised its option to acquire the units for a total purchase price of approximately $239,000.   The transaction was approved by the independent members of the Board of Trustees after considering that the value of the units had appreciated significantly since 1998 and 1999 and that the exercise price for the Company was substantially below the prices paid to acquire similar limited partner units in third party transactions.   The acquisition was effective January 1, 2009.

10.          Share-Based Compensation

Stock Options

We have various stock option plans (collectively referred to as the “PS Plans”).   Under the PS Plans, the Company has granted non-qualified options to certain trustees, officers and key employees to purchase the Company’s common shares at a price equal to the fair market value of the common shares at the date of grant.   Generally, options granted after December 31, 2002 vest generally over a five-year period and expire between eight years and ten years after the date they became exercisable.   The PS Plans also provide for the grant of restricted shares (see below) to officers, key employees and service providers on terms determined by an authorized committee of our Board.

We recognize compensation expense for share-based awards based upon their fair value on the date of grant amortized over the applicable vesting period (the “Fair Value Method”), net of estimates for future forfeitures.  

For the three and six months ended June 30, 2009, we recorded $900,000 and $1,500,000, respectively, in stock option compensation expense related to options granted after January 1, 2002, as compared to $951,000 and $1,367,000 for the same periods in 2008.  

A total of 1,485,000 stock options were granted during the six months ended June 30, 2009, 19,619 shares were exercised, and 79,000 shares were forfeited.   A total of 3,783,713 stock options were outstanding at June 30, 2009 (2,397,332 at December 31, 2008).  

Outstanding stock options are included on a one-for-one basis in our diluted weighted average shares, less a reduction for the treasury stock method applied to a) the average cumulative measured but unrecognized compensation expense during the period and b) the strike price proceeds expected from the employee upon exercise.

Restricted Share Units

Outstanding restricted share units vest over a five or eight-year period from the date of grant at the rate of one-fifth or one-eighth per year, respectively.   The employee receives additional compensation equal to the per-share dividends received by common shareholders with respect to restricted share units outstanding.   Such compensation is accounted for as dividends paid. Any dividends paid on units which are subsequently forfeited are expensed.   Upon vesting, the employee receives common shares equal to the number of vested restricted share units in exchange for the units.  

The total value of each restricted share unit grant, based upon the market price of our common shares at the date of grant, is amortized over the service period, net of estimates for future forfeitures, as compensation expense.   The related employer portion of payroll taxes is expensed as incurred.  

During the six months ended June 30, 2009, 99,050 restricted share units were granted, 42,022 restricted share units were forfeited and 90,633 restricted share units vested.   This vesting resulted in the issuance of 56,352 common shares.   In addition, cash compensation was paid to employees in lieu of 34,281 common shares based upon the market value of the shares at the date of vesting, and used to settle the employees’ tax liability generated by the vesting.  

At June 30, 2009, approximately 596,607 restricted share units were outstanding (630,212 at December 31, 2008).   A total of $2,580,000 and $4,593,000 in restricted share expense was recorded for the three and six months ended June 30, 2009, respectively, as compared to $2,533,000 and $4,891,000 for the same periods in 2008.   Restricted share expense includes amortization of the grant-date fair value of the units reflected as an increase to paid-in capital, as well as payroll taxes we incurred upon each respective vesting.

See also “net income per common share” above for further discussion regarding the impact of restricted share units on our net income per common and income allocated to common shareholders.

11.          Segment Information

Description of Each Reportable Segment

Our reportable segments reflect significant operating activities that are evaluated separately by management, comprised of the following segments which are organized based upon their operating characteristics.

Our self-storage segment comprises the direct ownership, development, and operation of traditional self-storage facilities in the U.S., and the ownership of equity interests in entities that own self-storage facilities in the U.S., and our interest in the operations of a facility in London, England.   Our Shurgard Europe segment comprises our interest in the self-storage and associated activities owned by Shurgard Europe.   See also Note 3 for a discussion of the disposition of an interest in, and deconsolidation of, Shurgard Europe effective March 31, 2008.  

Our ancillary segment includes (i) the reinsurance of policies against losses to goods stored by tenants in our self-storage facilities, (ii) merchandise sales, (iii) commercial property operations, and (iv) management of facilities for third parties and facilities owned by the Unconsolidated Entities.   During the three months ended March 31, 2009, we discontinued our truck rental and containerized storage operations, which previously had been included in our ancillary segment.   See “Discontinued Operations” in Note 2 for further discussion.  

Measurement of Segment Income (Loss) and Segment Assets – Self-Storage and Ancillary

The self-storage and ancillary segments are evaluated by management based upon the net segment income of each segment.   Net segment income represents net income in conformity with GAAP and our significant accounting policies as denoted in Note 2, before interest and other income, interest expense, and corporate general and administrative expense.   Interest and other income, interest expense, corporate general and administrative expense, and gains and losses on sales of real estate assets are not allocated to these segments because management does not utilize them to evaluate the results of operations of each segment.   In addition, there is no presentation of segment assets for these other segments because total assets are not considered in the evaluation of these segments.

Measurement of Segment Income (Loss) and Segment Assets – Shurgard Europe

Shurgard Europe’s operations are primarily independent of our other segments, with a separate management team that makes the financing, capital allocation, and other significant decisions.   As a result, this segment is evaluated by management as a stand-alone business unit.   The Shurgard Europe segment presentation includes all of the revenues, expenses, and operations of this business unit to the extent consolidated in our financial statements, and for periods following the deconsolidation of Shurgard Europe, the presentation below includes our equity share of Shurgard Europe’s operations, the interest and other income received from Shurgard Europe, as well as specific general and administrative expense, disposition gains, and foreign currency exchange gains and losses that management considers in evaluating our investment in Shurgard Europe.   At June 30, 2009, our condensed consolidated balance sheet includes an investment in Shurgard Europe with a book value of $268.5 million ($264.1 million at December 31, 2008) and a loan receivable from Shurgard Europe totaling €391.9 million ($550.5 million) ($552.4 million at December 31, 2008).

Presentation of Segment Information

The following table reconciles the performance of each segment, in terms of segment income, to our consolidated net income (amounts in thousands):

         For the three months ended June 30, 2009

  

  

         For the three months ended June 30, 2008  

  

         For the six months ended June 30, 2009

  

         For the six months ended June 30, 2008