UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

o		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 01-12846

PROLOGIS

(Exact name of registrant as specified in its charter)

Maryland (State or other jurisdiction of incorporation or organization)		74-2604728 (I.R.S. Employer Identification No.)

4545 Airport Way, Denver, Colorado (Address or principal executive offices)		80239 (Zip Code)

(303) 567-5000
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

     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 for the past 90 days.

Yes þ No o

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

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

Yes o No þ

     The number of shares outstanding of the Registrant’s common shares as of November 2, 2006 was 247,446,519.

 

 

PROLOGIS

INDEX

						Page
						Number(s)
PART I.		Financial Information
		Item 1.		Financial Statements:
				Consolidated Statements of Earnings and Comprehensive Income – Three and Nine Months ended September 30, 2006 and 2005			3
				Consolidated Balance Sheets –September 30, 2006 and December 31, 2005			5
				Consolidated Statements of Cash Flows – Nine Months ended September 30, 2006 and 2005			6
				Notes to Consolidated Financial Statements			7
				Report of Independent Registered Public Accounting Firm			27
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk			46
		Item 4.		Controls and Procedures			46
PART II.		Other Information
		Item 1.		Legal Proceedings			46
		Item 1A.		Risk Factors			47
		Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			47
		Item 3.		Defaults Upon Senior Securities			47
		Item 4.		Submission of Matters to a Vote of Security Holders			47
		Item 5.		Other Information			47
		Item 6.		Exhibits			47
Computation of Ratio of Earnings to Fixed Charges
Computation of Ratio of Earnings to Combined Fixed Charges
KPMG LLP Awareness Letter
Certification of Chief Executive Officer
Certification of Chief Financial Officer
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

PROLOGIS

CONSOLIDATED STATEMENTS OF

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Revenues:
Rental income		$	237,521			$	144,965			$	683,429			$	401,490
CDFS dispositions proceeds			311,840				355,524				1,050,704				956,110
Property management and other fees and incentives			20,421				17,321				79,318				50,326
Development management and other income			11,099				9,254				26,525				12,580
Total revenues			580,881				527,064				1,839,976				1,420,506
Expenses:
Rental expenses			59,753				36,866				175,399				108,578
Cost of CDFS dispositions			234,216				290,658				821,054				762,955
General and administrative			37,787				24,688				110,362				72,731
Depreciation and amortization			70,964				45,215				211,782				126,919
Merger integration and relocation expenses			—				8,534				2,723				12,337
Other expenses			2,977				3,030				8,924				6,312
Total expenses			405,697				408,991				1,330,244				1,089,832
Operating income			175,184				118,073				509,732				330,674
Other income (expense):
Earnings from unconsolidated property funds			11,215				12,217				78,629				34,992
Earnings from CDFS joint ventures and other unconsolidated investees			9,590				301				47,011				668
Interest expense			(77,417	)			(42,549	)			(216,933	)			(113,803	)
Interest income on long-term notes receivable			3,914				841				13,236				841
Interest and other income, net			5,313				3,210				10,596				6,657
Total other income (expense)			(47,385	)			(25,980	)			(67,461	)			(70,645	)
Earnings before minority interest			127,799				92,093				442,271				260,029
Minority interest			(565	)			(1,327	)			(2,541	)			(3,929	)
Earnings before certain net gains			127,234				90,766				439,730				256,100
Gains recognized on dispositions of certain non-CDFS business assets, net			—				—				13,709				—
Foreign currency exchange gains, net			9,202				4,742				16,449				8,323
Earnings before income taxes			136,436				95,508				469,888				264,423
Income taxes:
Current income tax expense			34,824				2,435				75,913				7,185
Deferred income tax (benefit) expense			(22,362	)			5,369				(16,780	)			8,190
Total income taxes			12,462				7,804				59,133				15,375
Earnings from continuing operations			123,974				87,704				410,755				249,048

(Continued)

PROLOGIS

CONSOLIDATED STATEMENTS OF
EARNINGS AND COMPREHENSIVE INCOME (CONTINUED)
(Unaudited)
(In thousands, except per share data)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Discontinued operations:
Income attributable to disposed properties and assets held for sale			4,111				5,017				15,953				11,586
Losses related to temperature-controlled distribution assets			—				—				—				(25,150	)
Gains recognized on dispositions:
Non-CDFS business assets			29,386				36,633				80,037				38,840
CDFS business assets			15,188				6,402				30,178				6,383
Total discontinued operations			48,685				48,052				126,168				31,659
Net earnings			172,659				135,756				536,923				280,707
Less preferred share dividends			6,354				6,354				19,062				19,062
Net earnings attributable to common shares			166,305				129,402				517,861				261,645
Other comprehensive income items:
Foreign currency translation gains (losses)			17,106				(13,055	)			50,761				(45,998	)
Unrealized gains (losses) on derivative contracts, net			(17,447	)			15,594				(15,080	)			7,827
Comprehensive income		$	165,964			$	131,941			$	553,542			$	223,474
Weighted average common shares outstanding — Basic			245,460				196,323				244,918				189,768
Weighted average common shares outstanding — Diluted			256,233				206,760				255,559				200,022
Net earnings per share attributable to common shares — Basic:
Continuing operations		$	0.48			$	0.42			$	1.59			$	1.21
Discontinued operations			0.20				0.24				0.52				0.17
Net earnings per share attributable to common shares — Basic		$	0.68			$	0.66			$	2.11			$	1.38
Net earnings per share attributable to common shares — Diluted:
Continuing operations		$	0.46			$	0.40			$	1.55			$	1.17
Discontinued operations			0.19				0.23				0.49				0.16
Net earnings per share attributable to common shares — Diluted		$	0.65			$	0.63			$	2.04			$	1.33
Distributions per common share		$	0.40			$	0.37			$	1.20			$	1.11

The accompanying notes are an integral part of these Consolidated Financial Statements.

PROLOGIS

CONSOLIDATED BALANCE SHEETS

		September 30,
		2006				December 31,
		(Unaudited)				2005
ASSETS
Real estate		$	13,007,695			$	11,875,130
Less accumulated depreciation			1,248,214				1,118,547
			11,759,481				10,756,583
Investments in and advances to unconsolidated investees			1,270,370				1,049,743
Cash and cash equivalents			519,234				203,800
Accounts and notes receivable			357,778				327,214
Other assets			955,519				788,840
Discontinued operations — assets held for sale			134,717				—
Total assets		$	14,997,099			$	13,126,180
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Debt		$	7,886,442			$	6,677,880
Accounts payable and accrued expenses			481,069				344,423
Other liabilities			678,679				557,210
Discontinued operations — assets held for sale			5,144				—
Total liabilities			9,051,334				7,579,513
Minority interest			52,679				58,644
Shareholders’ equity:
Series C Preferred Shares at stated liquidation preference of $50.00 per share; $0.01 par value; 2,000,000 shares issued and outstanding at September 30, 2006 and December 31, 2005			100,000				100,000
Series F Preferred Shares at stated liquidation preference of $25.00 per share; $0.01 par value; 5,000,000 shares issued and outstanding at September 30, 2006 and December 31, 2005			125,000				125,000
Series G Preferred Shares at stated liquidation preference of $25.00 per share; $0.01 par value; 5,000,000 shares issued and outstanding at September 30, 2006 and December 31, 2005			125,000				125,000
Common Shares; $0.01 par value; 247,124,641 shares issued and outstanding at September 30, 2006 and 243,781,142 shares issued and outstanding at December 31, 2005			2,471				2,438
Additional paid-in capital			5,751,334				5,606,017
Accumulated other comprehensive income			185,267				149,586
Distributions in excess of net earnings			(395,986	)			(620,018	)
Total shareholders’ equity			5,893,086				5,488,023
Total liabilities and shareholders’ equity		$	14,997,099			$	13,126,180

The accompanying notes are an integral part of these Consolidated Financial Statements.

PROLOGIS

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended
		September 30,
		2006				2005
Operating activities:
Net earnings		$	536,923			$	280,707
Minority interest share in earnings			2,541				3,929
Adjustments to reconcile net earnings to net cash provided by operating activities:
Straight-lined rents			(25,683	)			(5,230	)
Cost of share-based compensation awards			16,430				17,936
Depreciation and amortization			217,024				134,611
Amortization of deferred loan costs and net (premium) discount on debt			(5,272	)			3,352
Gains recognized on dispositions of non-CDFS business assets, net			(93,746	)			(38,840	)
Impairment charge and cumulative translation losses on assets held for sale			—				26,864
Equity in earnings from unconsolidated investees			(125,640	)			(35,660	)
Distributions from and changes in operating receivables of unconsolidated investees			86,118				40,098
Adjustments to foreign currency exchange amounts recognized			(9,141	)			(5,799	)
Deferred income tax (benefit) expense			(16,780	)			8,190
Increase in accounts receivable and other assets			(235,438	)			(86,449	)
Increase (decrease) in accounts payable and accrued expenses and other liabilities			219,288				(36,865	)
Net cash provided by operating activities			566,624				306,844
Investing activities:
Real estate investments			(2,644,108	)			(1,779,294	)
Cash consideration paid in Catellus Merger, net of cash acquired			—				(1,296,652	)
Purchase of ownership interests in property funds			(259,248	)			—
Tenant improvements and lease commissions on previously leased space			(53,415	)			(35,098	)
Recurring capital expenditures			(21,752	)			(17,535	)
Proceeds from dispositions of real estate assets			1,603,551				1,036,430
Proceeds from repayment of notes receivable			70,531				59,991
Increase in restricted cash for potential investment			(42,174	)			—
Investments in unconsolidated investees			(126,129	)			(42,275	)
Return of investment from unconsolidated investees			100,188				27,468
Net cash used in investing activities			(1,372,556	)			(2,046,965	)
Financing activities:							.
Net proceeds from sales and issuances of common shares under various common share plans			123,926				38,308
Distributions paid on common shares			(293,829	)			(207,246	)
Minority interest redemptions and distributions			(10,219	)			(12,787	)
Dividends paid on preferred shares			(19,062	)			(19,062	)
Debt and equity issuance costs paid			(8,727	)			(1,336	)
Repayment of debt assumed in Catellus Merger			—				(106,356	)
Net proceeds from lines of credit and short-term borrowings			701,870				2,096,923
Proceeds from issuance of senior notes and secured debt `			1,101,236				—
Payments on senior notes, secured debt and assessment bonds			(473,829	)			(111,271	)
Net cash provided by financing activities			1,121,366				1,677,173
Net increase (decrease) in cash and cash equivalents			315,434				(62,948	)
Cash and cash equivalents, beginning of period			203,800				236,529
Cash and cash equivalents, end of period		$	519,234			$	173,581

See Note 13 for information on non-cash investing and financing activities and other information.

The accompanying notes are an integral part of these Consolidated Financial Statements.

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.

General:

     Business. ProLogis, collectively with our consolidated subsidiaries (we, our, us, the Company or ProLogis), is a publicly held real estate investment trust (“REIT”) that owns, manages and develops (directly and through our unconsolidated investees) primarily industrial distribution properties in North America, Europe and Asia. Our business consists of three reportable business segments: (i) property operations, (ii) fund management and (iii) corporate distribution facilities services and other real estate development business (“CDFS business”). Our property operations segment represents the direct long-term ownership of industrial distribution and retail properties. Our fund management segment represents the long-term investment management of property funds and the properties they own. Our CDFS business segment primarily encompasses our development or acquisition of real estate properties that are generally contributed to a property fund in which we have an ownership interest and act as manager, or sold to third parties. See Note 12 for further discussion of our business segments.

     Basis of Presentation. The accompanying consolidated financial statements, presented in the U.S. dollar, are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. All material intercompany transactions with consolidated entities have been eliminated.

     The accompanying unaudited interim financial information has been prepared according to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. Our management believes that the disclosures presented in these financial statements are adequate to make the information presented not misleading. In our opinion, all adjustments and eliminations, consisting only of normal recurring adjustments, necessary to present fairly our financial position as of September 30, 2006 and our results of operations for the three and nine months ended September 30, 2006 and 2005, and cash flows for the nine months ended September 30, 2006 and 2005 have been included. The results of operations for such interim periods are not necessarily indicative of the results for the full year. The accompanying unaudited interim financial information should be read in conjunction with our December 31, 2005 Consolidated Financial Statements, as filed with the SEC in our Annual Report on Form 10-K.

     Certain amounts included in the accompanying consolidated financial statements for 2005 have been reclassified to conform to the 2006 financial statement presentation. These amounts include reclassifications in the consolidated statement of cash flows resulting in a decrease to operating cash flows of $20.8 million, an increase to investing cash flows of $27.5 million and a decrease to financing activities of $6.7 million, which we believe are immaterial to 2005.

     Adoption of New Accounting Pronouncements. The Emerging Issues Task Force (“EITF”) reached a consensus in June 2005 regarding EITF Issue 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 EITF agreed on a framework for evaluating when a general partner controls a limited partnership and whether the partnership should be consolidated. The Financial Accounting Standards Board (the “FASB”) ratified the consensus that was effective June 29, 2005 for all new or modified partnerships and effective January 1, 2006 for all existing partnerships. We adopted EITF 04-5 on January 1, 2006. As such, we performed an evaluation of each of our unconsolidated investees. We first determined whether the entity needed to be evaluated under EITF 04-5 based on the ownership and legal structure. Next, we evaluated whether the limited partners had substantive kick-out rights or participating rights, both as defined under EITF 04-5. We concluded that the unconsolidated investees that were subject to EITF 04-5 and needed to be evaluated should be accounted for under the equity method of accounting based on the rights provided to the limited partners under the governing documents of the respective entity.

     On December 16, 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share Based Payment” (“SFAS 123R”) that required companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the award’s fair value on the grant date and recognize the cost over the period during which an employee is required to provide service in exchange for the award, generally the vesting period.

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

We adopted SFAS 123R on January 1, 2006 using the modified prospective application. Prior to that date, we recognized the costs of our share-based compensation plans under SFAS No. 123 “Accounting and Disclosure of Stock BasedCompensation” that allowed us to continue to account for these plans under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). The impact of adoption of SFAS 123R is the inclusion of compensation expense within our statements of earnings, which were previously disclosed as pro forma amounts within the notes to our Consolidated Financial Statements. See Note 4.

     In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 (“APB 29”)” (“SFAS 153”), which was effective January 1, 2006. SFAS 153 amended APB 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaced it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. Previously under APB 29, in certain limited situations we were required to defer a portion of the proceeds received from a contribution of a property to an unconsolidated property fund that represented nonmonetary proceeds. SFAS 153 amended APB 29 such that we are no longer required to defer those nonmonetary proceeds. However, we are still required under SFAS No. 66, “Accounting for Sales of Real Estate”, to defer a portion of the gain based on the percentage of our continuing ownership interest in the property when we contribute a property to an unconsolidated investee. During the first nine months of 2006, we recognized $8.2 million of proceeds that historically would have been deferred under APB 29.

     Recent Accounting Pronouncements. In July 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”), was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new standard also provides guidance on various income tax accounting issues, including derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 and are to be applied to all tax positions upon initial adoption. Only tax positions that meet the “more-likely-than-not” recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 is to be reported as an adjustment to the opening balance of retained earnings for the year of adoption. We are currently assessing what impact, if any, the adoption of FIN 48 on January 1, 2007 will have on our financial position and results of operations.

     In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment” (“SAB 108”). SAB 108 is effective for fiscal years ending after November 15, 2006, although early application is encouraged, but not required. We will adopt SAB 108 for our fiscal year ending December 31, 2006. We are currently assessing what impact, if any, the adoption of SAB 108 will have on our financial position and results of operations.

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. This Statement applies to other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after December 15, 2007. We plan to adopt SFAS 157 beginning in the first quarter of 2008. We are currently assessing what impact, if any, the adoption of SFAS 157 will have on our financial position and results of operations.

2.

Mergers and Acquisitions:

     On September 15, 2005, Catellus Development Corporation, a publicly traded REIT, (“Catellus”) merged with and into Palmtree Acquisition Corporation, one of our subsidiaries, pursuant to an Agreement and Plan of Merger dated as of June 6, 2005 (the “Merger Agreement”), as amended (the “Catellus Merger”). At the time of the Catellus Merger, Catellus owned or held an ownership interest in 41.8 million square feet of industrial, office and retail properties of which approximately 92% was industrial space.

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     In connection with the Catellus Merger, we incurred merger integration costs, such as employee transition costs and severance costs for certain of our employees whose responsibilities became redundant after the Catellus Merger.

     Under the terms of the Merger Agreement, Catellus stockholders had the opportunity to elect to receive cash or our common shares for their Catellus stock. As a result of the Catellus Merger, we issued approximately 55.9 million of our common shares to former Catellus stockholders. We financed the cash portion of the Catellus Merger primarily through borrowings of $1.5 billion on a short-term bridge facility, which has been repaid.

     The following unaudited pro forma financial information for the three and nine months ended September 30, 2005, gives effect to the Catellus Merger as if it had occurred on January 1, 2005. The pro forma results (in millions, except per share amounts) are based on historical data and are not intended to be indicative of the results of future operations.

		Three Months Ended				Nine Months Ended
		September 30, 2005				September 30, 2005
Total revenues		$	601.0			$	1,710.6
Operating income		$	132.3			$	383.7
Net earnings attributable to common shares		$	123.5			$	269.2
Weighted average common shares outstanding – Basic			242.6				242.4
Weighted average common shares outstanding – Diluted			253.0				252.7
Net earnings per share attributable to common shares – Basic		$	0.51			$	1.11
Net earnings per share attributable to common shares – Diluted		$	0.49			$	1.08

3.

Unconsolidated Investees:

  Summary of Investments and Income

     Our investments in and advances to unconsolidated investees, which are accounted for under the equity method, are summarized by type of investee as follows (in thousands):

		September 30,				December 31,
		2006				2005
Property funds		$	949,634			$	755,320
CDFS joint ventures and other investees			320,736				294,423
Totals		$	1,270,370			$	1,049,743

     We recognize earnings or losses from our investments in unconsolidated investees consisting of our proportionate share of the net earnings or losses of these investees, including interest income on advances made to these investees, if any. In addition, we earn fees for providing services to the property funds, CDFS joint ventures and certain other investees. The amounts we have recognized from our investments in unconsolidated investees are summarized as follows (in thousands):

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Earnings (losses) from unconsolidated investees:
Property funds:
North America		$	5,874			$	5,831			$	53,731			$	17,291
Europe			2,973				4,392				16,622				12,338
Asia			2,368				1,994				8,276				5,363
Total property funds			11,215				12,217				78,629				34,992
CDFS joint ventures and other investees:
North America			8,560				32				44,013				(959	)
Europe			593				241				1,700				887
Asia			437				28				1,298				740
Total CDFS joint ventures and other investees			9,590				301				47,011				668
Total earnings from unconsolidated investees		$	20,805			$	12,518			$	125,640			$	35,660
Property management and other fees and incentives:
North America		$	9,545			$	8,595			$	46,554			$	24,836
Europe			9,128				7,533				26,076				22,189
Asia			1,748				1,193				6,688				3,301
Total property management and other fees and incentives		$	20,421			$	17,321			$	79,318			$	50,326

     Included in our earnings from CDFS joint ventures in North America for the three and nine months ended September 30, 2006 is income of $8.0 million and $35.0 million, respectively, representing our proportionate share of the earnings of a CDFS joint venture, “LAAFB JV”. The LAAFB JV was formed by Catellus to redevelop a U.S. Air Force base in Los Angeles, California in exchange for land parcels and certain rights to receive tax increment financing (“TIF”) proceeds over a period of time. As our investment in LAAFB JV is held in a taxable subsidiary, we also recognized a net income tax expense of $2.7 million and $14.6 million for the three and nine months ended September 30, 2006, respectively. See Note 5 for further discussion. As of September 30, 2006, the operations of the partnership were substantially complete, as all of the land had been redeveloped and sold and all TIF proceeds have been received.

   Property Funds

     Contributions of developed properties to a property fund allow us to realize a portion of the profits from our development activities while at the same time allowing us to maintain a long-term ownership interest in our developed properties. This business strategy also provides liquidity to fund our future development activities and generates fee income. The property funds generally own operating properties that we have contributed to them, although certain of the property funds have also acquired properties from third parties. We may receive additional ownership interests in the property funds as part of the proceeds generated by the contributions of properties to the property funds. We recognize our proportionate share of the earnings or losses of each property fund, earn fees for acting as the manager of each of the property funds and the fund properties, and may earn additional fees by providing other services including, but not limited to, acquisition, construction management and leasing activities. We may also earn incentive performance participation based on the investors’ returns.

     On January 4, 2006, we purchased the 80% ownership interests in each of ProLogis North American Properties Funds II, III and IV (collectively “Funds II-IV”) from our fund partner. On March 1, 2006, we contributed substantially all of these assets and associated liabilities to the ProLogis North American Industrial Fund (the “North American Industrial Fund”), which was formed in February 2006 (see below). In connection with these transactions, we recognized the following amounts in the respective financial statement line items for the nine months ended September 30, 2006, after deferral of $17.9 million due to our continuing 20% ownership interest in the North American Industrial Fund (in thousands):

CDFS disposition proceeds (1)		$	12,492
Property management and other fees and incentives (2)		$	21,958
Earnings from unconsolidated property funds (3)		$	37,113

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(1)		Represents the recognition of proceeds that we had previously deferred as part of CDFS proceeds upon the initial contributions of the properties to Funds II-IV.
(2)		Represents an incentive return we earned due to certain return levels achieved by our fund partner upon the termination of Funds II-IV.
(3)		Represents our proportionate share of the gain on termination recognized by Funds II-IV.

Information about our property funds is as follows:

		Ownership Percentage								Investment in and Advances to
		September 30,				December 31,				September 30,				December 31,
Property Fund		2006				2005				2006				2005
ProLogis California (1)			50.0	%			50.0	%		$	112,852			$	115,743
ProLogis North American Properties Fund I (1)			41.3	%			41.3	%			30,813				33,241
ProLogis North American Properties Fund II-IV (2)			—				20.0	%			—				12,410
ProLogis North American Properties Fund V (3)			11.2	%			11.3	%			58,961				53,104
ProLogis North American Properties Fund VI (1)			20.0	%			20.0	%			39,422				42,227
ProLogis North American Properties Fund VII (1)			20.0	%			20.0	%			31,809				32,543
ProLogis North American Properties Fund VIII (1)			20.0	%			20.0	%			15,287				15,602
ProLogis North American Properties Fund IX (1)			20.0	%			20.0	%			14,064				14,274
ProLogis North American Properties Fund X (1)			20.0	%			20.0	%			15,550				15,968
ProLogis North American Properties Fund XI (1)			20.0	%			20.0	%			31,857				33,094
ProLogis North American Industrial Fund (4)			20.0	%			—				72,153				—
ProLogis European Properties (“PEPR”) (5)			24.0	%			21.0	%			399,559				283,435
ProLogis Japan Properties Fund I (1)			20.0	%			20.0	%			86,827				103,679
ProLogis Japan Properties Fund II (1)(6)			20.0	%			—				40,480				—
Totals										$	949,634			$	755,320

(1)		We have one fund partner in each of these property funds.
(2)		As discussed above, on January 4, 2006, we purchased the 80% ownership interests of our fund partner in each of these property funds and subsequently contributed substantially all of the assets and associated liabilities into the ProLogis North American Industrial Fund.
(3)		We refer to the combined entities in which we have ownership interests as one property fund named ProLogis North American Properties Fund V. Our ownership percentage is based on our levels of ownership interest in these different entities. We are committed to offer to contribute certain existing industrial distribution properties in the United States and Mexico to ProLogis North American Properties Fund V, prior to offering for contribution or sale to any third party, subject to certain conditions, through December 31, 2006. During the nine months ended September 30, 2006, we contributed 18 buildings to ProLogis North American Properties Fund V. We estimate our remaining commitment under this arrangement to be approximately $200 million at September 30, 2006. On January 9, 2006, a preferred unit holder in a subsidiary of ProLogis North American Properties Fund V exercised its option to put its interest to us for $55.0 million, which we acquired. We had an agreement with ProLogis North American Properties Fund V that enabled us to put this interest to the fund at the same price after June 30, 2006. On August 4, 2006, we exercised our option and received payment from ProLogis North American Properties Fund V.
(4)		In February 2006, we formed the North American Industrial Fund, with ten institutional investors, which will primarily own recently developed industrial distribution properties in major distribution markets throughout the United States and Canada. We refer to the combined entities in which we have ownership interests as one property fund named ProLogis North American Industrial Fund. Our ownership percentage is based on our levels of ownership interest in these different entities. We are committed to offer to contribute substantially all of our stabilized industrial development properties in Canada and the United States to the North American Industrial Fund, except for the specific properties included in our commitment to ProLogis North American Properties Fund V. The North American Industrial Fund has equity commitments, which expire in February 2009, aggregating approximately $1.5 billion from third party investors, of which $1.2 billion was unfunded at September 30, 2006. During the nine months ended September 30, 2006, we contributed 10 buildings for aggregate proceeds of $128.5 million to the North American Industrial Fund in addition to the assets that were acquired from Funds II-IV, as discussed above. We receive property and asset management fees for services provided to the property fund and will also have the potential for incentive performance participation based on the investors’ returns.
(5)		In September 2006, PEPR, (previously referred to as ProLogis European Properties Fund), completed an initial public offering (“IPO”) of ordinary units to trade on the Euronext Amsterdam N.V.’s Eurolist under the ticker

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

		symbol PEPR. Selling unit holders offered 49.8 million ordinary units, including an over-allotment option, for aggregate proceeds of €715 million, which were paid to the selling unit holders. PEPR did not receive any proceeds from the offering. As the manager of the property fund, we received an initial incentive allocation of €53.5 million paid in additional ordinary units based on the internal rate of return that the pre-IPO unit holders earned during their pre-IPO holding period. This increased our investment by $68.6 million and our ownership interest to 24.0%. The incentive return was adjusted through a cash settlement based on the average closing price of the ordinary units during the 30-day, post-IPO period. The final incentive return was determined on October 22, 2006 as approximately $109 million, including the initial allocation of units and net of certain expenses. As the amount was not fixed and determinable at September 30, 2006, the revenue will be recognized in the fourth quarter of 2006. In addition, as of September 30, 2006, we had an obligation to the pre-IPO unit holders under a tax indemnification agreement of approximately $36 million related to properties we contributed prior to the IPO. The majority of this obligation will be reversed into earnings in the fourth quarter of 2006, as we are no longer obligated for indemnification with respect to those properties.
		In connection with the IPO, we entered into a property contribution agreement under which we are committed to offer to contribute certain stabilized properties to PEPR having an aggregate contribution value of €200 million (the currency equivalent of $253.2 million at September 30, 2006), in specified markets in Europe through September 30, 2007, subject to the property meeting certain leasing and other criteria. We may be obligated to indemnify PEPR for certain future capital gain tax liabilities that may be incurred by PEPR related to the properties we contribute under this agreement.
(6)		ProLogis Japan Properties Fund II was formed on September 1, 2005. We are committed to offer to contribute all of the properties that we develop and stabilize in Japan through August 2008 to this property fund, subject to the property meeting certain leasing and other criteria. During the nine months ended September 30, 2006, we contributed five properties to this property fund and the property fund acquired seven properties from third parties. ProLogis Japan Properties Fund II has an equity commitment of $600.0 million from our fund partner, which expires in August 2008, of which $421.5 million was unfunded at September 30, 2006.

     Summarized financial information of the property funds (for the entire entity, not our proportionate share) and our investment in such funds is presented below (dollars in millions):

		2006
		North
		America				Europe				Asia				Total
For the three months ended September 30, 2006:
Revenues		$	126.0			$	107.6			$	33.0			$	266.6
Net earnings (1)		$	26.3			$	11.3			$	8.9			$	46.5
For the nine months ended September 30, 2006:
Revenues		$	360.8			$	304.9			$	86.9			$	752.6
Net earnings (1)(2)		$	247.9			$	71.1			$	33.7			$	352.7
As of September 30, 2006:
Total assets		$	5,129.7			$	4,783.7			$	1,935.1			$	11,848.5
Amounts due to us		$	16.9			$	7.1			$	70.2			$	94.2
Third party debt (3)		$	2,905.5			$	2,497.5			$	786.2			$	6,189.2
Total liabilities		$	3,141.3			$	2,969.8			$	1,068.6			$	7,179.7
Equity		$	1,982.2			$	1,807.6			$	866.5			$	4,656.3
Our weighted average ownership (4)			23.2	%			24.0	%			20.0	%			23.0	%
Our investment balance (5)		$	422.7			$	399.6			$	127.3			$	949.6
Deferred proceeds, net of amortization (6)		$	85.9			$	124.4			$	63.8			$	274.1

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

		2005
		North
		America				Europe				Asia				Total
For the three months ended September 30, 2005:
Revenues		$	125.2			$	94.7			$	18.5			$	238.4
Net earnings		$	20.6			$	17.9			$	8.1			$	46.6
For the nine months ended September 30, 2005:
Revenues		$	372.4			$	275.2			$	48.5			$	696.1
Net earnings		$	65.6			$	49.9			$	22.4			$	137.9
As of December 31, 2005:
Total assets		$	4,786.6			$	4,052.0			$	1,230.1			$	10,068.7
Amounts due to us		$	9.0			$	15.7			$	71.3			$	96.0
Third party debt (3)		$	2,690.7			$	1,991.2			$	535.1			$	5,217.0
Total liabilities		$	2,921.0			$	2,409.6			$	639.8			$	5,970.4
Equity		$	1,864.1			$	1,637.9			$	590.3			$	4,092.3
Our weighted average ownership (4)			23.5	%			21.0	%			20.0	%			22.1	%
Our investment balance (5)		$	368.2			$	283.4			$	103.7			$	755.3
Deferred proceeds, net of amortization (6)		$	77.7			$	105.5			$	44.1			$	227.3

   CDFS joint ventures and other investees

     At September 30, 2006, we had investments in entities that perform some of our CDFS business activities (the “CDFS joint ventures”) and certain other investments. These joint ventures include entities that develop and own industrial operating properties and also include entities that perform land, multi-use, retail and residential development activity. The other operating joint ventures include entities that own a hotel property and office properties. Our investments in and advances to these entities were as follows (in thousands):

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

		September 30,				December 31,
		2006				2005
CDFS joint ventures:
North America		$	78,446			$	113,008
Europe			12,524				12,238
Asia			114,274				57,165
Total CDFS joint ventures		$	205,244			$	182,411
Other investees:
Operating joint ventures		$	87,628			$	84,731
Other			27,864				27,281
Total other investees			115,492				112,012
Total		$	320,736			$	294,423

     In September 2006, we invested in an entity in China that we present on a consolidated basis. This entity has an investment interest in an entity that owns and develops retail properties and is accounted for under the equity method of accounting. The investment balance of $39.6 million is included in our investments in CDFS joint ventures. As part of this transaction, we may be required to invest up to $42.2 million based on the attainment of certain performance criteria. This amount is in escrow and is included in other assets at September 30, 2006. In addition, we have a commitment to provide a financial guarantee to this investee for up to 600 million Renminbi (the currency equivalent of $75.9 million at September 30, 2006).

4.

Long-Term Compensation:

   Share Options

     We have granted various share options to our employees and trustees with graded vesting at various rates over periods from one to 10 years, subject to certain conditions. Each share option is exercisable into one common share. The holders of share options granted before 2001 earn dividend equivalent units (“DEUs”) each year until the earlier of the date the underlying share option is exercised or the expiration date of the underlying share option. Share options granted generally vest over a four-year period and have an exercise price equal to the average of the high and low market prices on the date of grant.

     Share options outstanding at September 30, 2006 were as follows:

										Weighted Average
		Number of						Expiration		Remaining Life
		Options				Exercise Price		Date		(in years)
Outside Trustees Plan			120,000			$19.75 - $43.80		2009-2015		5.9
Share options:
1997 grants			142,293			$21.22		2007		0.9
1998 grants			663,527			$20.94 - $21.09		2008		2.1
1999 grants			653,288			$17.19 - $18.62		2009		3.0
2000 grants			658,742			$21.75 - $24.25		2010		4.0
2001 grants			554,016			$20.67 - $22.02		2011		5.0
2002 grants			1,015,769			$22.98 - $24.75		2007, 2012		5.6
2003 grants			1,266,245			$24.90 - $31.26		2013		7.0
2004 grants			1,723,980			$29.41 - $41.50		2014		8.0
2005 grants			1,090,512			$40.86 - $45.46		2015		9.2
2006 grants			31,518			$53.07 - $57.14		2016		9.6
Total			7,919,890

     The weighted average fair value of the share options granted during the nine months ended September 30, 2006 was $9.87 per option. We calculated the fair value of the options granted in 2006 using a Black-Scholes pricing model with the following assumptions: i) weighted average risk free interest rate of 4.74%; ii) weighted average dividend yield of 3.48%; iii) volatility of 20.25%; and iv) option life of 5.8 years. We use historical data to estimate dividend yield, share option exercises, expected term and employee departure behavior used in the Black-Scholes pricing model. The risk free rate for periods within the expected term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant. To calculate expected volatility, we use historical volatility of our common stock.

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

   Restricted Share Units

     Restricted share units (“RSUs”), in the form of common shares, are granted at a rate of one common share per RSU from time to time to our employees. The RSUs are valued on the grant date based upon the market price of a common share on that date. We recognize the value of the RSUs granted as compensation expense over the applicable vesting period, which generally is four or five years. The RSUs do not carry voting rights during the vesting period, but do generally earn DEUs that vest according to the underlying RSU. In addition, annually we issue fully vested deferred share units to our trustees, which are expensed at the time of grant.

   Performance Shares

     Certain employees are granted performance share awards (“PSAs”). The grants are based on performance criteria, established in advance, for each employee eligible for the grant. If a PSA is earned based on the performance criteria, the recipient must continue to be employed by us until the end of the vesting period before any portion of the grant is vested. The PSAs carry no voting rights during this vesting period, but do earn DEUs that are vested at the end of the vesting period, which is generally two or three years. The PSAs are valued on the grant date, based upon the market price of a common share on that date. We recognize the value of the PSAs granted as compensation expense over the vesting period.

     Included in the PSAs outstanding at September 30, 2006 were certain PSAs that will be earned based on our ranking in a defined subset of companies in the National Association of Real Estate Investment Trust’s (“NAREIT’s”) published index. These PSAs will vest over a three-year period. The amount of PSAs to be issued will be based on our ranking at the end of the three-year period, and may range from zero to 355,000 shares. For purposes of calculating compensation expense, we consider the PSAs to have a market condition and therefore we have estimated the fair value of the PSAs using a pricing valuation model.

   Dividend Equivalent Units

     DEUs in the form of common shares are earned at a rate of one common share per DEU for certain share options granted through 2001, RSUs and PSAs. Prior to the adoption of SFAS 123R, we recognized the value of the DEUs issued as compensation expense, based on the market price of a common share on the grant date, over the vesting period of the underlying share award. With the adoption of SFAS 123R, we now treat the DEUs as dividends, which are charged to retained earnings and factored into the computation of the fair value of the underlying share award at grant date.

   Summary of Activity

     The activity for the nine months ended September 30, 2006, with respect to our share options, is presented below.

		Options Outstanding								Options Exercisable
						Weighted								Weighted				Weighted
						Average								Average				Average
		Number of				Exercise				Number of				Exercise				Life
		Options				Price				Options				Price				(in years)
Balance at December 31, 2005			8,873,820			$	29.19
Granted			31,518			$	54.58
Exercised			(897,862	)		$	26.15
Forfeited			(87,586	)		$	36.01
Balance at September 30, 2006			7,919,890			$	29.56				5,554,378			$	25.64				6.1

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

     Activity with respect to our RSUs and PSAs is as follows:

						Weighted
						Average				Number of
		Number of				Original				Shares
		Shares				Value				Vested
Balance at December 31, 2005			1,792,335								645,025
Granted			404,843
Exercised			(285,979	)
Forfeited			(7,926	)
Balance at September 30, 2006			1,903,273			$	40.43				457,921

     During the nine months ended September 30, 2006, we recognized $16.4 million of compensation expense under the provisions of SFAS 123R. This includes expense related to awards granted to our outside trustees and is net of $5.3 million that was capitalized due to our development and leasing activities. During the nine months ended September 30, 2005, under the provisions of APB 25, we recognized $17.9 million of compensation expense, net of $3.6 million that was capitalized due to our development and leasing activities. With the adoption of SFAS 123R, we now recognize the compensation cost associated with stock options that was previously disclosed in the notes to our Consolidated Financial Statements and we treat DEUs as dividends, which are charged to retained earnings and factored into the computation of the fair value of the underlying share award at grant date. Had we not adopted SFAS 123R for the nine months ended September 30, 2006, our net earnings attributable to common shares would have been $515.9 million and our basic and diluted net earnings per share attributable to common shares would have been $2.11 and $2.03, respectively.

     Had we adopted SFAS 123R on January 1, 2005, our net earnings attributable to common shares would have changed as follows:

		Three Months Ended				Nine Months Ended
		September 30, 2005				September 30, 2005
Net earnings attributable to common shares:
As reported		$	129,402			$	261,645
Pro forma		$	130,159			$	263,650
Net earnings per share attributable to common shares:
As reported – Basic		$	0.66			$	1.38
As reported – Diluted		$	0.63			$	1.33
Pro forma – Basic		$	0.66			$	1.39
Pro forma – Diluted		$	0.64			$	1.34

     Total compensation cost related to unvested share options, RSUs and PSAs was $57.0 million as of September 30, 2006, prior to adjustments for capitalized amounts due to our development and leasing activities and forfeited awards. This expense will be recognized through 2010, which equates to a weighted average period of 1.9 years.

5.

Income Taxes

     We and one of our consolidated subsidiaries have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, (the “Code”), and are not generally required to pay federal income taxes if we make distributions in excess of taxable income and meet the REIT requirements of the Code. Certain of our consolidated subsidiaries in the United States are subject to federal income taxes and we are taxed in certain states in which we operate. In addition, many of the foreign countries where we have operations do not recognize REITs or do not accord REIT status under their respective tax laws to our entities that operate in their jurisdiction. Accordingly, we recognize income taxes for these jurisdictions, as appropriate.

     During the nine months ended September 30, 2006 and 2005, we recognized current income tax expense of $75.9 million and $7.2 million, respectively. Current income tax expense is a function of the level of income recognized by our taxable subsidiaries operating primarily in the CDFS business segment, state income taxes, taxes incurred in foreign jurisdictions and interest associated with our income tax liabilities.

     During the nine months ended September 30, 2006, we recognized a net deferred tax benefit of $16.8 million, compared with net deferred tax expense of $8.2 million in the same period of 2005. Deferred income tax is a function of the period’s temporary differences (items that are treated differently for tax purposes than for financial

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

reporting purposes), the utilization of tax net operating losses generated in prior years that had been previously recognized as deferred income tax assets and deferred income tax liabilities related to indemnification agreements related to certain contributions to property funds.

     For federal income tax purposes, the Catellus Merger was treated as a tax-free transaction resulting in a carryover basis for tax purposes. For financial reporting purposes and in accordance with purchase accounting, we recorded all of the acquired assets and liabilities at the estimated fair values at the date of acquisition. For our taxable subsidiaries, we recognized the deferred income tax liabilities that represent the tax effect of the difference between the tax basis carried over and the fair values of these assets at the date of acquisition. As taxable income is generated in these subsidiaries, we recognize a deferred tax benefit in earnings as a result of the reversal of the deferred income tax liability previously recorded at the acquisition date and we record current income tax expense representing the entire current income tax liability.

6.

Discontinued Operations:

     Discontinued operations represent a component of an entity that has either been disposed of or is classified as held for sale if both the operations and cash flows of the component have been or will be eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. The results of operations of the component of the property or a business are reported as discontinued operations for all periods presented. A property is classified as held for sale when certain criteria are met. At such time, the respective assets and liabilities are presented separately on our balance sheet and depreciation and amortization is no longer recognized. Assets held for sale are reported at the lower of their carrying amount or their estimated fair value less the costs to sell.

     Properties disposed of to third parties are considered discontinued operations unless such properties were developed under a pre-sale agreement. Properties contributed to property funds in which we maintain an ownership interest and act as manager are not considered discontinued operations due to our continuing involvement with the properties. Discontinued operations recognized directly by our unconsolidated investees, if any, are not reflected separately from our investment balance or separately from the net earnings or losses of those equity investees.

     Income attributable to discontinued operations is summarized as follows (in millions):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Rental income		$	6.4			$	9.3			$	39.9			$	25.8
Rental expenses			(1.5	)			(2.3	)			(17.8	)			(7.1	)
Depreciation and amortization			(0.8	)			(2.0	)			(5.2	)			(6.8	)
Interest expense			—				—				(0.9	)			(0.3	)
Income attributable to disposed properties and assets held for sale		$	4.1			$	5.0			$	16.0			$	11.6

   Assets Disposed Of

     The following information relates to properties disposed of to third parties that are recorded as discontinued operations (in millions, except number of properties):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Non-CDFS business assets:
Number of properties			17				31				53				35
Net proceeds from dispositions		$	80.0			$	80.1			$	433.7			$	86.9
Net gains from dispositions		$	29.4			$	36.6			$	80.0			$	38.8
CDFS business assets:
Number of properties			7				3				12				5
Net proceeds from dispositions		$	117.1			$	33.4			$	222.6			$	43.2
Net gains from dispositions		$	15.2			$	6.4			$	30.2			$	6.4

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

     Our temperature-controlled distribution assets in France were sold in July 2005. In connection with the sale, we received total proceeds of €30.8 million including a note receivable of €23.9 million that was paid in full in January 2006. We recognized impairment charges and cumulative translation losses of $26.9 million during the six months ended June 30, 2005 to reflect our investment in this business at its estimated fair value less costs to sell. These charges are included in losses related to temperature-controlled distribution assets in our Consolidated Statement of Earnings and Comprehensive Income.

   Assets Held For Sale

     At September 30, 2006, we had 23 office, retail and industrial properties that were classified as held for sale and accordingly, the operations of these properties were included in discontinued operations for all periods presented in our Consolidated Statements of Earnings and Comprehensive Income and the respective assets and liabilities are presented separately in our Consolidated Balance Sheet at September 30, 2006.

7.

Distributions and Dividends:

   Common Share Distributions

     Cash distributions of $0.40 per common share for each of the first, second and third quarters of 2006 were paid on February 28, 2006, May 31, 2006, and August 31, 2006, respectively, to holders of common shares on February 15, 2006, May 16, 2006, and August 16, 2006, respectively. Quarterly common share distributions paid in 2006 are based on the annual distribution level for 2006 of $1.60 per common share (as compared to $1.48 per common share in 2005) set by the Board of Trustees (“Board”) in December 2005. The payment of common share distributions is subject to the discretion of the Board and is dependent upon our financial condition and operating results, and may be adjusted at the discretion of the Board during the year.

   Preferred Share Dividends

     The annual dividends on our cumulative redeemable preferred shares are $4.27 per share (Series C) and $1.6875 per share (Series F and Series G). On each of March 31, 2006, June 30, 2006, and September 29, 2006 we paid quarterly dividends of $1.0675 per share (Series C) and $0.4219 per share (Series F and Series G). Such dividends are payable quarterly in arrears on the last day of March, June, September and December. Dividends on preferred shares are payable when, and if, they have been declared by the Board, out of funds legally available for the payment of dividends.

8.

Earnings Per Common Share:

     We determine basic earnings per share based on the weighted average number of common shares outstanding during the period. We determine diluted earnings per share based on the weighted average number of common shares outstanding combined with the incremental weighted average common shares that would have been outstanding assuming all potentially dilutive instruments were converted into common shares at the earliest date possible. The following table sets forth the computation of our basic and diluted earnings per share (in thousands, except per share amounts):

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Net earnings attributable to common shares		$	166,305			$	129,402			$	517,861			$	261,645
Minority interest			565				1,327				2,541				3,929
Adjusted net earnings attributable to common shares		$	166,870			$	130,729			$	520,402			$	265,574
Weighted average common shares outstanding — Basic			245,460				196,323				244,918				189,768
Incremental weighted average effect of conversion of limited partnership units			5,142				5,539				5,218				5,540
Incremental weighted average effect of potentially dilutive instruments (1)			5,631				4,898				5,423				4,714
Weighted average common shares outstanding — Diluted			256,233				206,760				255,559				200,022
Net earnings per share attributable to common shares — Basic		$	0.68			$	0.66			$	2.11			$	1.38
Net earnings per share attributable to common shares — Diluted		$	0.65			$	0.63			$	2.04			$	1.33

9.

Real Estate:

     Real estate assets owned directly by us primarily consist of income producing properties, properties under development and land held for future development. Our real estate assets, presented at cost, include the following (in thousands):

		September 30,				December 31,
		2006				2005
Industrial operating properties (1):
Improved land		$	2,127,543			$	1,774,923
Buildings and improvements			7,886,052				6,955,983
Retail operating properties (2):
Improved land			62,992				66,848
Buildings and improvements			201,510				221,405
Land subject to ground leases and other (3)			453,519				792,668
Properties under development, including cost of land (4)			911,847				884,345
Land held for development (5)			1,090,941				1,045,042
Other investments (6)			273,291				133,916
Total real estate assets			13,007,695				11,875,130
Less accumulated depreciation			1,248,214				1,118,547
Net real estate assets		$	11,759,481			$	10,756,583

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

(5)		Land held for future development consisted of 6,077 and 6,568 acres at September 30, 2006 and December 31, 2005, respectively.
(6)		Other investments primarily include: (i) restricted funds that are held in escrow pending the completion of tax-deferred exchange transactions involving operating properties; (ii) earnest money deposits associated with potential acquisitions; (iii) costs incurred during the pre-acquisition due diligence process; (iv) costs incurred during the pre-construction phase related to future development projects; and (v) investments in our corporate office buildings.

     We directly own real estate assets in North America (Canada, Mexico and the United States), Europe (Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Spain, Sweden and the United Kingdom) and Asia (China, Japan, Korea and Singapore).

     During the nine months ended September 30, 2006, we acquired 62 industrial operating properties aggregating 11.5 million square feet with a combined purchase price of $627.1 million.

     For our direct-owned properties, the largest customer and the 25 largest customers accounted for 2.2% and 18.2%, respectively, of our annualized collected base rents at September 30, 2006.

10.

Debt:

     Our debt consisted of the following (dollars in thousands):

		September 30, 2006								December 31, 2005
		Weighted								Weighted
		Average				Amount				Average				Amount
		Interest Rate				Outstanding				Interest Rate				Outstanding
Unsecured lines of credit and short-term borrowings			3.47	%		$	2,760,770				3.28	%		$	2,240,054
Senior notes			5.89	%			3,582,298				6.16	%			2,759,675
Secured debt			6.47	%			1,509,724				6.50	%			1,643,586
Assessment bonds			3.83	%			33,650				3.87	%			34,565
Totals			5.15	%		$	7,886,442				5.27	%		$	6,677,880

     We have a $3.4 billion global senior credit facility (“Global Line”), which was amended and increased from a $2.6 billion facility in June 2006. The funds may be drawn in U.S. dollar, euro, Japanese yen, British pound sterling, Chinese renminbi, South Korean won and Canadian dollar. The weighted average interest rate at September 30, 2006 of 3.47% represents the weighted average base interest rates using local currency rates on borrowings outstanding at the end of the period.

     On March 27, 2006, we issued $450.0 million of 5.5% senior notes due April 1, 2012 and $400.0 million of 5.75% senior notes due April 1, 2016. We received net proceeds of $838.7 million, after all offering costs that were used to repay borrowings under our Global Line, the bridge facility from the Catellus Merger and other general corporate purposes.

     In July 2006, we completed the exchange and registration of senior notes that were issued in a private placement in November 2005. We also repaid $250.0 million of senior notes that matured.

     On August 24, 2006, we issued $250.0 million of senior notes due August 24, 2009. Interest on the notes accrues at a variable rate based on the London Interbank Offered Rate (“LIBOR”) plus a margin (5.65% at September 30, 2006). We utilized the net proceeds of $250.0 million to repay borrowings under our Global Line and other general corporate purposes.

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

11.

Shareholders’ Equity:

     During the nine months ended September 30, 2006, we sold and/or issued common shares under various common share plans, including share-based compensation plans, as follows (in thousands):

		Shares				Proceeds
1999 dividend reinvestment and share purchase plan			56			$	2,889
Continuous equity offering plan			1,899			$	106,377
Long-term incentive plan and share option plan for outside trustees			1,187			$	24,054
Employee share purchase plan			22			$	872

     Limited partnership units were redeemed for 180,000 common shares during the nine months ended September 30, 2006.

12.

Business Segments:

     We have three reportable business segments:

	•		Property operations — representing the direct long-term ownership of industrial distribution and retail properties. This segment also includes the expenses related to the management and leasing of properties that we own and properties owned by the unconsolidated property funds. Each operating property is considered to be an individual operating segment having similar economic characteristics that are combined within the reportable segment based upon geographic location. Included in this segment are properties we developed and properties we acquired and rehabilitated or repositioned within the CDFS business segment with the intention of contributing the property to a property fund or selling to a third party. Our operations in the property operations business segment are in North America (Canada, Mexico and the United States), Europe (properties are located in Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Spain and the United Kingdom and are generally pending contribution to a property fund or sale to a third party) and Asia (properties are located in China, Japan, Korea, and Singapore and are generally pending contribution to a property fund or sale to a third party).
	•		Fund management — representing the long-term investment management of unconsolidated property funds and the properties they own. We recognize our proportionate share of the earnings or losses from our investments in unconsolidated property funds operating in North America, Europe and Asia. Along with the income recognized under the equity method, we include fees and incentives earned for services performed on behalf of the property funds and interest earned on advances to the property funds, if any. We utilize our leasing and property management expertise in our property operations segment for managing the properties owned by property funds in this segment, and we report the costs as part of rental expenses in the property operations segment. Each investment in a property fund is considered to be an individual operating segment having similar economic characteristics that are combined within the reportable segment based upon geographic location. Our operations in the fund management segment are in North America (Mexico and the United States), Europe (Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Spain, Sweden, and the United Kingdom), and Asia (Japan).
	•		CDFS business — primarily encompasses our development or acquisition of real estate properties that are rehabilited and / or repositioned, which are generally contributed to a property fund in which we have an ownership interest and act as manager, or sold to third parties. We engage in commercial mixed-use development activities generally with the intention of selling the land or completed projects to third parties. We also have investments in several unconsolidated entities that perform development activities and we include our proportionate share of their earnings or losses in this segment. Additionally, we include fees earned for development activities performed on behalf of customers or third parties, interest income earned on notes receivable related to asset sales and gains or losses on the disposition of land parcels when our development plans no longer include the parcels. The separate activities in this segment are considered to be individual operating segments having similar economic characteristics that are combined within the reportable segment based upon geographic location. Our CDFS business segment operations are in North America (Canada, Mexico and the United States), in Europe (Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Spain, Sweden and the United Kingdom) and in Asia (China, Japan and Korea).

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

     We have other operating segments that do not meet the threshold criteria to disclose as a reportable segment, primarily the management of land subject to ground leases in the United States. Each ground lease is considered to be an individual operating segment.

     The assets of the CDFS business segment generally include properties under development, land held for development and our investments in and advances to CDFS joint ventures. During the period between the completion of development, rehabilitation or repositioning of a property and the date the property is contributed to a property fund or sold to a third party, the property and its associated rental income and rental expenses are included in the property operations segment because the primary activity associated with the property during that period is leasing. Upon contribution or sale, the resulting gain or loss is included in the income of the CDFS business segment. The assets of the fund management segment include our investments in and advances to the unconsolidated property funds.

     We present the operations and net gains and losses associated with properties sold to third parties generally as discontinued operations. In addition, as of September 30, 2006, we had 23 office, retail and industrial properties classified as assets held for sale, whose operations are included in discontinued operations. Accordingly, these amounts are excluded from the segment presentation. See Note 6.

     Reconciliations are presented below for: (i) each reportable business segment’s revenue from external customers to our total revenues; (ii) each reportable business segment’s net operating income from external customers to our earnings before minority interest; and (iii) each reportable business segment’s assets to our total assets. Our chief operating decision makers rely primarily on net operating income and similar measures to make decisions about allocating resources and assessing segment performance. The applicable components of our revenues, earnings before minority interest and assets, excluding discontinued operations, are allocated to each reportable business segment’s revenues, net operating income and assets. Items that are not directly assignable to a segment, such as certain corporate income and expenses, are reflected as reconciling items. The following reconciliations are presented in thousands:

PROLOGIS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Revenues:
Property operations (1):
North America		$	206,322			$	132,387			$	607,561			$	381,130
Europe			10,006				4,234				23,943				7,134
Asia			9,185				6,042				20,057				10,927
Total property operations segment			225,513				142,663				651,561				399,191
Fund management (2):
North America			15,419				14,426				100,285				42,127
Europe			12,101				11,925				42,698				34,527
Asia			4,116				3,187				14,964				8,664
Total fund management segment			31,636				29,538				157,947				85,318
CDFS business (3):
North America			40,534				3,471				337,725				225,302
Europe			6,863				140,553				444,887				241,317
Asia			289,141				221,796				351,281				503,113
Total CDFS business segment			336,538				365,820				1,133,893				969,732
Total segment revenue			593,687				538,021				1,943,401				1,454,241
Other – North America			12,008				2,299				31,868				2,299
Reconciling item (4)			(24,814	)			(13,256	)			(135,293	)			(36,034	)
Total revenues		$	580,881			$	527,064			$	1,839,976			$	1,420,506
Net operating income (loss):
Property operations (5):
North America		$	153,818			$	98,122			$	451,705			$	278,469
Europe			7,253				2,791				16,486				3,626
Asia			8,288				5,409				17,994				9,040
Total property operations segment			169,359				106,322				486,185				291,135
Fund management (2):
North America			15,419				14,426				100,285				42,127
Europe			12,101				11,925				42,698				34,527
Asia			4,116				3,187				14,964				8,664
Total fund management segment			31,636				29,538				157,947				85,318
CDFS business (6):
North America			21,186				1,446				119,339				50,794
Europe			5,867				21,706				102,375				39,532
Asia			72,405				48,907				82,545				110,674
Total CDFS business segment			99,458				72,059				304,259				201,000
Total segment net operating income			300,453				207,919				948,391				577,453
Other – North America			8,409				1,777				21,845				1,777
Reconciling items:
Earnings from other unconsolidated investees			(94	)			289				3,583				468
General and administrative expenses			(37,787	)			(24,688	)			(110,362	)			(72,731	)
Depreciation and amortization expense			(70,964	)			(45,215	)			(211,782	)			(126,919	)
Merger integration and relocation expenses			-				(8,534	)			(2,723	)			(12,337	)
Other expenses			(114	)			(116	)			(344	)			(536	)
Interest expense			(77,417	)			(42,549	)			(216,933	)			(113,803	)
Interest and other income, net			5,313				3,210				10,596				6,657
Total reconciling items			(181,063	)			(117,603	)			(527,965	)			(319,201	)
Total earnings before minority interest		$	127,799			$	92,093			$	442,271			$	260,029