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EX-12.1 - EXHIBIT 12.1 - Whitestone REITexhibit121computationofrat.htm
EX-31.1 - EXHIBIT 31.1 - Whitestone REITexhibit311certificationofc.htm
EX-31.2 - EXHIBIT 31.2 - Whitestone REITexhibit312certificationofc.htm
EX-32.1 - EXHIBIT 32.1 - Whitestone REITexhibit321certificationofc.htm
EX-32.2 - EXHIBIT 32.2 - Whitestone REITexhibit322certificationofc.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

OR

[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission file number 001-34855
WHITESTONE REIT
(Exact Name of Registrant as Specified in Its Charter)
 
Maryland
 
76-0594970
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

2600 South Gessner, Suite 500
Houston, Texas
 
77063
(Address of Principal Executive Offices)
 
(Zip Code)

(713) 827-9595
(Registrant's Telephone Number, Including Area Code)
 
N/A
(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 requirements for the past 90 days.  ýYes     ¨No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ýYes    ¨No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ¨                                                                                      Accelerated filer ý
Non-accelerated filer ¨                                  Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨Yes   ý No

As of August 4, 2014, there were 22,713,237 common shares of beneficial interest, $0.001 par value per share, outstanding.



PART I - FINANCIAL INFORMATION


PART II - OTHER INFORMATION





PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Whitestone REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

 
 
June 30, 2014
 
December 31, 2013
 
 
(unaudited)
 
 
ASSETS
Real estate assets, at cost
 
 
 
 
Property
 
$
548,515

 
$
546,274

Accumulated depreciation
 
(70,602
)
 
(66,008
)
Total real estate assets
 
477,913

 
480,266

Cash and cash equivalents
 
5,042

 
6,491

Marketable securities
 
982

 
877

Escrows and acquisition deposits
 
2,419

 
2,095

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
10,316

 
9,929

Unamortized lease commissions and loan costs
 
5,910

 
6,227

Prepaid expenses and other assets
 
2,543

 
2,089

Total assets
 
$
505,125

 
$
507,974

 
 
 
 
 
LIABILITIES AND EQUITY
Liabilities:
 
 
 
 
Notes payable
 
$
264,123

 
$
264,277

Accounts payable and accrued expenses
 
12,405

 
12,773

Tenants' security deposits
 
3,807

 
3,591

Dividends and distributions payable
 
6,609

 
6,418

Total liabilities
 
286,944

 
287,059

Commitments and contingencies:
 

 

Equity:
 
 
 
 
Preferred shares, $0.001 par value per share; 50,000,000 shares authorized; none issued and outstanding as of June 30, 2014 and December 31, 2013
 

 

Common shares, $0.001 par value per share; 400,000,000 shares authorized; 22,683,913 and 21,943,700 issued and outstanding as of June 30, 2014 and December 31, 2013, respectively
 
23

 
22

Additional paid-in capital
 
299,291

 
291,571

Accumulated deficit
 
(84,911
)
 
(75,721
)
Accumulated other comprehensive loss
 
(242
)
 
(54
)
Total Whitestone REIT shareholders' equity
 
214,161

 
215,818

Noncontrolling interest in subsidiary
 
4,020

 
5,097

Total equity
 
218,181

 
220,915

Total liabilities and equity
 
$
505,125

 
$
507,974



See accompanying notes to Consolidated Financial Statements

1


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Property revenues
 
 
 
 
 
 
 
 
Rental revenues
 
$
13,839

 
$
11,812

 
$
27,812

 
$
22,813

Other revenues
 
3,835

 
2,983

 
7,649

 
5,851

Total property revenues
 
17,674

 
14,795

 
35,461

 
28,664

 
 
 
 
 
 
 
 
 
Property expenses
 
 
 
 
 
 
 
 
Property operation and maintenance
 
4,142

 
3,348

 
7,802

 
6,413

Real estate taxes
 
2,251

 
2,012

 
4,561

 
3,810

Total property expenses
 
6,393

 
5,360

 
12,363

 
10,223

 
 
 
 
 
 
 
 
 
Other expenses (income)
 
 
 
 
 
 
 
 
General and administrative
 
3,582

 
2,516

 
6,539

 
4,960

Depreciation and amortization
 
3,908

 
3,260

 
7,816

 
6,333

Interest expense
 
2,449

 
2,613

 
4,821

 
5,062

Interest, dividend and other investment income
 
(19
)
 
(69
)
 
(40
)
 
(88
)
Total other expense
 
9,920

 
8,320

 
19,136

 
16,267

 
 
 
 
 
 
 
 
 
Income before loss on sale or disposal of assets and income taxes
 
1,361

 
1,115

 
3,962

 
2,174

 
 
 
 
 
 
 
 
 
Provision for income taxes
 
(57
)
 
(72
)
 
(141
)
 
(137
)
Loss on sale or disposal of assets
 
(24
)
 
(40
)
 
(109
)
 
(48
)
 
 
 
 
 
 
 
 
 
Net income
 
1,280

 
1,003

 
3,712

 
1,989

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
27

 
33

 
87

 
70

 
 
 
 
 
 
 
 
 
Net income attributable to Whitestone REIT
 
$
1,253

 
$
970

 
$
3,625

 
$
1,919










See accompanying notes to Consolidated Financial Statements

2


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Basic and Diluted Earnings Per Share:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.05

 
$
0.06

 
$
0.16

 
$
0.11

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,235

 
16,891

 
22,030

 
16,855

Diluted
 
22,443

 
17,111

 
22,192

 
17,073

 
 
 
 
 
 
 
 
 
Distributions declared per common share / OP unit
 
$
0.2850

 
$
0.2850

 
$
0.5700

 
$
0.5700

 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
1,280

 
$
1,003

 
$
3,712

 
$
1,989

 
 
 
 
 
 
 
 
 
Other comprehensive gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging activities
 
(259
)
 
761

 
(297
)
 
493

Unrealized gain (loss) on available-for-sale marketable securities
 
22

 
(88
)
 
105

 
215

 
 
 
 
 
 
 
 
 
Comprehensive income
 
1,043

 
1,676

 
3,520

 
2,697

 
 
 
 
 
 
 
 
 
Less: Comprehensive income attributable to noncontrolling interests
 
23

 
57

 
82

 
95

 
 
 
 
 
 
 
 
 
Comprehensive income attributable to Whitestone REIT
 
$
1,020

 
$
1,619

 
$
3,438

 
$
2,602




See accompanying notes to Consolidated Financial Statements

3


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(Unaudited)
(in thousands)

 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
Total
 
Noncontrolling
 
 
 
 
Common Shares
 
Paid-In
 
Accumulated
 
Comprehensive
 
Shareholders'
 
interests
 
Total
 
 
Shares
 
Amount
 
Capital
 
Deficit
 
Gain (Loss)
 
Equity
 
Units
 
Dollars
 
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2013
 
21,944

 
$
22

 
$
291,571

 
$
(75,721
)
 
$
(54
)
 
$
215,818

 
562

 
$
5,097

 
$
220,915

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange of noncontrolling interest OP units for common shares
 
96

 

 
870

 

 
(1
)
 
869

 
(96
)
 
(869
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange offer costs
 

 

 
(6
)
 

 

 
(6
)
 

 

 
(6
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares - ATM Program, net of offering costs (1)
 
378

 
1

 
5,266

 

 

 
5,267

 

 

 
5,267

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares under dividend reinvestment plan
 
4

 

 
50

 

 

 
50

 

 

 
50

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase of common shares (2)
 
(2
)
 

 
(24
)
 

 

 
(24
)
 

 

 
(24
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation
 
264

 

 
1,564

 

 

 
1,564

 

 

 
1,564

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Distributions
 

 

 

 
(12,815
)
 

 
(12,815
)
 


(290
)
 
(13,105
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on change in fair value of available-for-sale marketable securities
 

 

 

 

 
103

 
103

 

 
2

 
105

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on change in value of cash flow hedge
 

 

 

 

 
(290
)
 
(290
)
 

 
(7
)
 
(297
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
3,625

 

 
3,625

 

 
87

 
3,712

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2014
 
22,684

 
$
23

 
$
299,291

 
$
(84,911
)
 
$
(242
)
 
$
214,161

 
466

 
$
4,020

 
$
218,181


(1) 
Net of offering costs of $0.1 million.
(2) 
During the three months ended June 30, 2014, the Company acquired common shares held by employees who tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted shares.

See accompanying notes to Consolidated Financial Statements


4


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
 
Six Months Ended June 30,
 
 
2014
 
2013
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
Net income
 
$
3,712

 
$
1,989

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
7,816

 
6,333

Amortization of deferred loan costs
 
405

 
554

Amortization of notes payable discount
 
153

 
299

Gain on sale of marketable securities
 

 
(41
)
Loss on sale or disposal of assets and properties
 
109

 
48

Bad debt expense
 
1,051

 
715

Share-based compensation
 
1,564

 
667

Changes in operating assets and liabilities:
 
 
 
 
Escrows and acquisition deposits
 
(324
)
 
1,619

Accrued rent and accounts receivable
 
(1,438
)
 
(966
)
Unamortized lease commissions
 
(570
)
 
(517
)
Prepaid expenses and other assets
 
334

 
246

Accounts payable and accrued expenses
 
(797
)
 
(2,990
)
Tenants' security deposits
 
216

 
324

Net cash provided by operating activities
 
12,231

 
8,280

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Acquisitions of real estate
 

 
(58,403
)
Additions to real estate
 
(4,990
)
 
(2,476
)
Proceeds from sales of marketable securities
 

 
747

Net cash used in investing activities
 
(4,990
)
 
(60,132
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Distributions paid to common shareholders
 
(12,598
)
 
(9,639
)
Distributions paid to OP unit holders
 
(310
)
 
(363
)
Proceeds from issuance of common shares, net of offering costs
 
5,267

 

Payments of exchange offer costs
 
(6
)
 
(23
)
Proceeds from notes payable
 

 
20,200

Proceeds from revolving credit facility, net
 
3,000

 
58,400

Repayments of notes payable
 
(4,019
)
 
(15,844
)
Payments of loan origination costs
 

 
(1,403
)
Repurchase of common shares
 
(24
)
 

Net cash provided by (used in) financing activities
 
(8,690
)
 
51,328

 
 
 
 
 
Net decrease in cash and cash equivalents
 
(1,449
)
 
(524
)
Cash and cash equivalents at beginning of period
 
6,491

 
6,544

Cash and cash equivalents at end of period
 
$
5,042

 
$
6,020


See accompanying notes to Consolidated Financial Statements

5


Whitestone REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

 
 
Six Months Ended June 30,
 
 
2014
 
2013
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
4,447

 
$
4,597

Cash paid for taxes
 
$
238

 
$
237

Non cash investing and financing activities:
 
 
 
 
Disposal of fully depreciated real estate
 
$
2,560

 
$
185

Financed insurance premiums
 
$
888

 
$
883

Value of shares issued under dividend reinvestment plan
 
$
50

 
$
47

Accrued offering costs
 
$

 
$
13

Value of common shares exchanged for OP units
 
$
870

 
$
1,056

Change in fair value of available-for-sale securities
 
$
105

 
$
215

Change in fair value of cash flow hedge
 
$
(297
)
 
$
493

Debt assumed with acquisitions of real estate
 
$

 
$
11,100

Interest supplement assumed with acquisition of real estate
 
$

 
$
932



























See accompanying notes to Consolidated Financial Statements


6

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

The use of the words “we,” “us,” “our,” “Company” or “Whitestone” refers to Whitestone REIT and our consolidated subsidiaries, except where the context otherwise requires.

1.  INTERIM FINANCIAL STATEMENTS
 
The consolidated financial statements included in this report are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2013 are derived from our audited consolidated financial statements as of that date.  The unaudited financial statements as of June 30, 2014 have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information on a basis consistent with the annual audited consolidated financial statements and with the instructions to Form 10-Q.
 
The consolidated financial statements presented herein reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position of Whitestone and our subsidiaries as of June 30, 2014, and the results of operations for the three and six month periods ended June 30, 2014 and 2013, the consolidated statements of changes in equity for the six month period ended June 30, 2014 and cash flows for the six month periods ended June 30, 2014 and 2013.  All of these adjustments are of a normal recurring nature.  The results of operations for the interim periods are not necessarily indicative of the results expected for a full year.  The statements should be read in conjunction with the audited consolidated financial statements and the notes thereto which are included in our Annual Report on Form 10-K for the year ended December 31, 2013.
 
Business.  Whitestone was formed as a real estate investment trust ("REIT"), pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998.  In July 2004, we changed our state of organization from Texas to Maryland pursuant to a merger where we merged directly with and into a Maryland REIT formed for the sole purpose of the reorganization and the conversion of each of our outstanding common shares of beneficial interest of the Texas entity into 1.42857 common shares of beneficial interest of the Maryland entity.  We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership.  We currently conduct substantially all of our operations and activities through the Operating Partnership.  As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.  As of June 30, 2014 and December 31, 2013, Whitestone owned and operated 60 commercial properties in and around Houston, Dallas, San Antonio, Chicago and Phoenix.


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Consolidation.  We are the sole general partner of the Operating Partnership and possess full legal control and authority over the operations of the Operating Partnership.  As of June 30, 2014 and December 31, 2013, we owned a majority of the partnership interests in the Operating Partnership.  Consequently, the accompanying consolidated financial statements include the accounts of the Operating Partnership.  All significant inter-company balances have been eliminated. Noncontrolling interests in the accompanying consolidated financial statements represents the share of equity and earnings of the Operating Partnership allocable to holders of partnership interests other than us.  Net income or loss is allocated to noncontrolling interests based on the weighted average percentage ownership of the Operating Partnership during the period.  Issuance of additional common shares of beneficial interest in Whitestone (the "common shares") and units of limited partnership interest in the Operating Partnership that are convertible into cash or, at our option, common shares on a one-for-one basis (the “OP units”) changes the ownership interests of both the noncontrolling interests and Whitestone.
  
Basis of Accounting.  Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.
 

7

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

Use of Estimates.   The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that we use include the estimated fair values of properties acquired, the estimated useful lives for depreciable and amortizable assets and costs, the estimated allowance for doubtful accounts, the estimated fair value of interest rate swaps and the estimates supporting our impairment analysis for the carrying values of our real estate assets.  Actual results could differ from those estimates.
 
Reclassifications.  We have reclassified certain prior period amounts in the accompanying consolidated financial statements in order to be consistent with the current period presentation.  These reclassifications had no effect on net income, total assets, total liabilities or equity.
 
Marketable Securities. We classify our existing marketable equity securities as available-for-sale in accordance with the Financial Accounting Standards Board's ("FASB") Investments-Debt and Equity Securities guidance. These securities are carried at fair value with unrealized gains and losses reported in equity as a component of accumulated other comprehensive income or loss. The fair value of the marketable securities is determined using Level 1 inputs under FASB Accounting Standards Codification ("ASC") 820, "Fair Value Measurements and Disclosures." Level 1 inputs represent quoted prices available in an active market for identical investments as of the reporting date. Gains and losses on securities sold are based on the specific identification method, and are reported as a component of interest, dividend and other investment income.

Derivative Instruments and Hedging Activities. We occasionally utilize derivative financial instruments, principally interest rate swaps, to manage our exposure to fluctuations in interest rates. We have established policies and procedures for risk assessment, and the approval, reporting and monitoring of derivative financial instruments. We recognize our interest rate swaps as cash flow hedges with the effective portion of the changes in fair value recorded in comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. Any ineffective portion of a cash flow hedges' change in fair value is recorded immediately into earnings. Our cash flow hedges are determined using Level 2 inputs under ASC 820. Level 2 inputs represent quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations whose inputs are observable. As of June 30, 2014, we consider our cash flow hedges to be highly effective.
        
Development Properties. Land, buildings and improvements are recorded at cost. Expenditures related to the development of real estate are carried at cost which includes capitalized carrying charges and development costs. Carrying charges, primarily interest, real estate taxes, loan fees, and direct and indirect development costs related to buildings under construction, are capitalized as part of construction in progress. The capitalization of such costs ceases when the property, or any completed portion, becomes available for occupancy. For the three months ended June 30, 2014, approximately $26,000 and $7,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2014, approximately $51,000 and $32,000 in interest expense and real estate taxes, respectively, were capitalized. For the three months ended June 30, 2013, approximately $33,000 and $25,000 in interest expense and real estate taxes, respectively, were capitalized, and for the six months ended June 30, 2013, approximately $69,000 and $49,000 in interest expense and real estate taxes, respectively, were capitalized.

Share-Based Compensation.   From time to time, we award nonvested restricted common share awards or restricted common share unit awards, which may be converted into common shares, to executive officers and employees under our 2008 Long-Term Equity Incentive Ownership Plan (the “2008 Plan”).  The vast majority of the awarded shares and units vest when certain performance conditions are met.  We recognize compensation expense when achievement of the performance conditions is probable based on management's most recent estimates using the fair value of the shares as of the grant date. We recognized $1,234,000 and $311,000 in share-based compensation for the three months ended June 30, 2014 and 2013, respectively, and we recognized $1,607,000 and $667,000 in share-based compensation for the six months ended June 30, 2014 and 2013, respectively.


8

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

Noncontrolling Interests.  Noncontrolling interests is the portion of equity in a subsidiary not attributable to a parent.  The ownership interests not held by the parent are considered noncontrolling interests.  Accordingly, we have reported noncontrolling interests in equity on the consolidated balance sheets but separate from Whitestone's equity.  On the consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to Whitestone and noncontrolling interests.  The consolidated statement of changes in equity is included for quarterly financial statements, including beginning balances, activity for the period and ending balances for shareholders' equity, noncontrolling interests and total equity.
 
See our Annual Report on Form 10-K for the year ended December 31, 2013 for further discussion on significant accounting policies.
 
Recent Accounting Pronouncements.  In July 2013, the FASB issued guidance permitting the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815 ("Derivatives and Hedging"), in addition to the interest rates on direct Treasury obligations of the U.S. government and LIBOR. This guidance is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. We do not expect the pronouncement to have a significant impact on our consolidated financial statements.

3. MARKETABLE SECURITIES

All of our marketable securities were classified as available-for-sale securities as of June 30, 2014 and December 31, 2013. Available-for-sale securities consisted of the following (in thousands):

 
 
June 30, 2014
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
1,106

 
$

 
$
(124
)
 
$
982

Total available-for-sale securities
 
$
1,106

 
$

 
$
(124
)
 
$
982



 
 
December 31, 2013
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate sector common stock
 
$
1,106

 
$

 
$
(229
)
 
$
877

Total available-for-sale securities
 
$
1,106

 
$

 
$
(229
)
 
$
877


During the three and six months ended June 30, 2014, no available-for-sale securities were sold. During the three and six months ended June 30, 2013, available-for-sale securities were sold for total proceeds of $747,000. The gross realized gains and losses on these sales during the three months ended June 30, 2013 were $44,000 and $3,000, respectively. For the purpose of determining gross realized gains and losses, the cost of securities sold is based on specific identification. A net unrealized holding loss on available-for-sale securities in the amount of $124,000 and $194,000 for the six months ended June 30, 2014 and 2013, respectively, has been included in accumulated other comprehensive income.


9

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

4. ACCRUED RENTS AND ACCOUNTS RECEIVABLE, NET

Accrued rents and accounts receivable, net consists of amounts accrued, billed and due from tenants, allowance for doubtful accounts and other receivables as follows (in thousands):

 
 
June 30, 2014
 
December 31, 2013
 
 
 
 
 
Tenant receivables
 
$
7,308

 
$
5,731

Accrued rents and other recoveries
 
7,599

 
7,895

Allowance for doubtful accounts
 
(4,591
)
 
(3,697
)
Total
 
$
10,316

 
$
9,929


5. UNAMORTIZED LEASE COMMISSIONS AND LOAN COSTS

Costs which have been deferred consist of the following (in thousands):
 
 
June 30, 2014
 
December 31, 2013
 
 
 
 
 
Lease commissions
 
$
6,986

 
$
6,641

Deferred financing cost
 
5,076

 
5,146

Total cost
 
12,062

 
11,787

Less: lease commissions accumulated amortization
 
(3,817
)
 
(3,629
)
Less: deferred financing cost accumulated amortization
 
(2,335
)
 
(1,931
)
Total cost, net of accumulated amortization
 
$
5,910

 
$
6,227



10

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

6. DEBT

Certain subsidiaries of Whitestone are the borrowers under various financing arrangements. These subsidiaries are separate legal entities and their respective assets and credit are not available to satisfy the debt of Whitestone or any of its other subsidiaries.

Debt consisted of the following as of the dates indicated (in thousands):
Description
 
June 30, 2014
 
December 31, 2013
Fixed rate notes
 
 
 
 
$10.5 million, LIBOR plus 2.00% Note, due September 24, 2018 (1)
 
$
10,500

 
$
10,500

$50.0 million, 0.84% plus 1.75% to 2.50% Note, due February 3, 2017 (2)
 
50,000

 
50,000

$37.0 million 3.76% Note, due December 1, 2020
 
36,550

 
37,000

$6.5 million 3.80% Note, due January 1, 2019
 
6,434

 
6,500

$20.2 million 4.28% Note, due June 6, 2023
 
20,200

 
20,200

$1.0 million 4.75% Note, due December 31, 2014
 
1,000

 
1,087

$16.5 million 4.97% Note, due September 26, 2023
 
16,450

 
16,450

$15.1 million 4.99% Note, due January 6, 2024
 
15,060

 
15,060

$9.2 million, Prime Rate less 2.00%, due December 29, 2017 (3)
 
7,882

 
7,875

$11.1 million 5.87% Note, due August 6, 2016
 
11,754

 
11,900

$3.0 million 6.00% Note, due March 31, 2021
 

 
2,905

$0.9 million 2.97% Note, due November 28, 2014
 
493

 

Floating rate notes
 
 
 
 
Unsecured line of credit, LIBOR plus 1.75% to 2.50%, due February 3, 2017
 
87,800

 
84,800

 
 
$
264,123

 
$
264,277


(1) 
Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term.

(2) 
Promissory note includes an interest rate swap that fixed the LIBOR portion of our $50 million term loan under our unsecured credit facility at 0.84%.

(3) 
Promissory note includes an interest rate swap that fixed the interest rate at 5.72% for the duration of the term. As part of our acquisition of Paradise Plaza, we recorded a discount on the note of $1.3 million, which amortizes into interest expense over the life of the loan and results in an imputed interest rate of 4.13%.

On December 23, 2013, we, operating through our subsidiary, Whitestone Woodlake Plaza, LLC, a Delaware limited liability company, entered into a $6.5 million promissory note (the "Woodlake Note"), with a fixed interest rate of 3.80% payable to Western Reserve Life Assurance Company of Ohio and a maturity of January 1, 2019. Proceeds from the Woodlake Note were used to repay a portion of our unsecured revolving credit facility.

On December 16, 2013, we, operating through our subsidiary, Whitestone Anthem Marketplace, LLC, a Delaware limited liability company, entered into a $15.1 million promissory note (the "Anthem Note"), with a fixed interest rate of 4.99% payable to Citigroup Global Markets Realty Corporation and a maturity of January 6, 2024. Proceeds from the Anthem Note were used to repay a portion of our unsecured revolving credit facility.
    
On November 26, 2013, we, operating through our subsidiary, Whitestone Industrial-Office LLC, a Texas limited liability company ("Whitstone Industrial"), entered into a $37.0 million promissory note (the "Industrial Note"), with a fixed interest rate of 3.76% payable to Jackson Life National Insurance Company and a maturity of December 1, 2020. Proceeds from the Industrial Note were used to repay our existing $26.9 million floating rate loan that matured on December 1, 2013. The remainder of the proceeds were used to pay off approximately $10.1 million in fixed rate indebtedness maturing in 2014.


11

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

The Industrial Note is a non-recourse loan secured by Whitestone Industrial's nine properties, including Corporate Park Woodland, Holly Hall Industrial Park, Interstate 10 Warehouse, Main Park, Plaza Park, Westbelt Plaza, Westgate Service Center, Corporate Park West and Dairy Ashford.

On September 26, 2013, we, operating through our subsidiary, Whitestone Uptown Tower, LLC, a Delaware limited liability company ("Whitestone Uptown"), entered into a $16.5 million promissory note (the "Uptown Note"), with a fixed interest rate of 4.97% payable to Morgan Stanley Capital Holdings LLC and a maturity of September 26, 2023. Proceeds from the Uptown Note were used to repay a portion of our unsecured revolving credit facility.

On September 24, 2013, we, operating through our subsidiary, Whitestone Terravita Marketplace, LLC, a Delaware limited liability company ("Whitestone Terravita"), entered into a $10.5 million promissory note (the "Terravita Note"), with an applicable interest rate of LIBOR plus 2.00%, payable to Bank of America, N.A. and a maturity of September 24, 2018. Proceeds from the Terravita Note were used to repay a portion of our unsecured revolving credit facility.

The Terravita Note is a non-recourse loan secured by Whitestone Terravita's Terravita Marketplace property, located in Scottsdale, Arizona, and a limited guarantee by the Operating Partnership. In conjunction with the Terravita Note, a deed of trust was executed by Whitestone Terravita that contains customary terms and conditions, including representations, warranties and covenants by Whitestone Terravita that include, without limitation, assignment of rents, warranty of title, insurance requirements and maintenance, use and management of the property.

On June 19, 2013, we assumed a $11.1 million promissory note as part of our acquisition of Mercado at Scottsdale Ranch (see Note 14). The 5.87% fixed interest rate note matures on August 16, 2016. In conjunction with our acquisition, we received an interest rate supplement from the seller in the amount of $932,000, which we will accrete into expense over the life of the note. As a result of the supplement, the imputed interest rate is 3.052%, which we consider to be an appropriate market rate.
    
On May 31, 2013, we, operating through our subsidiary, Whitestone Pinnacle of Scottsdale, LLC, a Delaware limited liability company ("Whitestone Pinnacle"), refinanced our $14.1 million promissory note, with an applicable interest rate of 5.695% and a maturity of June 1, 2013, with a $20.2 million promissory note (the "Pinnacle Note") payable to Cantor Commercial Real Estate Lending, L.P. with an applicable interest rate of 4.2805%, and a maturity of June 6, 2023.
    
The Pinnacle Note is a non-recourse loan secured by Whitestone Pinnacle's Pinnacle of Scottsdale property, located in Scottsdale, Arizona, and a limited guarantee by Whitestone. In conjunction with the Pinnacle Note, a deed of trust was executed by Whitestone Pinnacle that contains customary terms and conditions, including representations, warranties and covenants by Whitestone Pinnacle that include, without limitation, assignment of rents, warranty of title, insurance requirements and maintenance, use and management of the property.

As of June 30, 2014, our $125.8 million in secured debt was collateralized by 17 properties with a carrying value of $157.6 million.  Our loans contain restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and are secured by deeds of trust on certain of our properties and by assignment of the rents and leases associated with those properties.  As of June 30, 2014, we were in compliance with all loan covenants.

On February 4, 2013, we, through our Operating Partnership, entered into an unsecured credit facility (the “Facility”) with the lenders party thereto, with BMO Capital Markets and Wells Fargo Securities, LLC, as co-lead arrangers and joint book runners, Bank of Montreal, as administrative agent (the "Agent"), Wells Fargo Bank, National Association, as syndication agent, and U.S. Bank National Association, as documentation agent. The Facility amended and restated our previous unsecured credit facility. We plan to use the Facility for property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and retenanting of properties in our portfolio.

In addition to a $125 million unsecured borrowing capacity under the revolving loan, the Facility also includes a $50 million term loan and permits the Operating Partnership to increase the borrowing capacity under the Facility to a total of $225 million, upon the satisfaction of certain conditions. The Facility will mature on February 3, 2017, and provides that the Operating Partnership may extend the maturity date for one year subject to certain conditions, including the payment of an extension fee.


12

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

Borrowings under the Facility accrue interest (at the Operating Partnership's option) at a Base Rate or an Adjusted LIBOR plus an applicable margin based upon our then-existing leverage. Base Rate means the higher of: (a) the Agent's prime commercial rate, (b) the sum of (i) average rate quoted the Agent by two or more federal funds brokers selected by the Agent for sale to the Agent at face value of federal funds in the secondary market in an amount equal or comparable to the principal amount for which such rate is being determined, plus (ii) 0.5%, and (c) the LIBOR rate for such day plus 1.00%. Adjusted LIBOR means LIBOR divided by one minus the Eurodollar Reserve Percentage. The Eurodollar Reserve Percentage means the maximum reserve percentage at which reserves are imposed by the Board of Governors of the Federal Reserve System on eurocurrency liabilities.
 
We are the guarantor for funds borrowed by the Operating Partnership under the Facility. The Facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, maximum secured indebtedness to total asset value, minimum EBITDA (earnings before interest, taxes, depreciation, amortization and extraordinary items) to fixed charges and maintenance of net worth. The Facility also contains customary events of default with customary notice and cure, including, without limitation, nonpayment, breach of covenant, misrepresentation of representations and warranties in a material respect, cross-default to other major indebtedness, change of control, bankruptcy and loss of REIT tax status. As of June 30, 2014, we were in compliance with all covenants.

As of June 30, 2014, $137.8 million was drawn on the Facility, and our remaining borrowing capacity was $37.2 million. See Note 15 for additional information regarding borrowings on the Facility subsequent to June 30, 2014. Proceeds from the Facility were used for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and retenanting of properties in our portfolio and working capital.

Scheduled maturities of our outstanding debt as of June 30, 2014 were as follows (in thousands):
Year
 
Amount Due
 
 
 
2014
 
$
2,200

2015
 
1,820

2016
 
13,229

2017
 
147,926

2018
 
11,856

Thereafter
 
87,092

Total
 
$
264,123

 

7.  DERIVATIVES AND HEDGING ACTIVITIES

The fair value of our interest rate swaps is as follows (in thousands):
 
 
Balance Sheet Location
 
Estimated Fair Value
Interest rate swaps:
 
 
 
 
June 30, 2014
 
Accounts payable and accrued expenses
 
$
1,352

December 31, 2013
 
Accounts payable and accrued expenses
 
$
1,231


On November 1, 2013, we, through our subsidiary, Whitestone Terravita, entered into an interest rate swap with Bank of America, N.A. that fixed the LIBOR portion of our $10.5 million term loan at 1.55%. See Note 6 for additional information regarding the Terravita Note. The swap began on November 1, 2013 and will mature on September 24, 2018. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings.
    

13

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

On March 8, 2013, we, through our Operating Partnership, entered into an interest rate swap with U.S. Bank National Association that fixed the LIBOR portion of our $50.0 million term loan under our unsecured credit facility at 0.84%. See Note 6 for additional information regarding our credit facility. The swap began on January 7, 2014 and will mature on February 3, 2017. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings.

A summary of our interest rate swap activity is as follows (in thousands):
 
 
Amount Recognized as Comprehensive Income (Loss)
 
Location of Gain (Loss) Recognized in Earnings
 
Amount of Gain (Loss) Recognized in Earnings (1)
Three months ended June 30, 2014
 
$
(259
)
 
Interest expense
 
$
(192
)
Three months ended June 30, 2013
 
$
761

 
Interest expense
 
$
(88
)
 
 
 
 
 
 
 
Six months ended June 30, 2014
 
$
(297
)
 
Interest expense
 
$
(382
)
Six months ended June 30, 2013
 
$
493

 
Interest expense
 
$
(176
)

(1) 
We did not recognize any ineffective portion of our interest rate swaps in earnings for the three or six months ended June 30, 2014 and 2013.

8.  EARNINGS PER SHARE
 
Basic earnings per share for our common shareholders is calculated by dividing income from continuing operations excluding amounts attributable to unvested restricted shares and the net income attributable to noncontrolling interests by our weighted average common shares outstanding during the period.  Diluted earnings per share is computed by dividing the net income attributable to common shareholders excluding amounts attributable to unvested restricted shares and the net income attributable to noncontrolling interests by the weighted average number of common shares including any dilutive unvested restricted shares.
 
Certain of our performance-based restricted common shares are considered participating securities that require the use of the two-class method for the computation of basic and diluted earnings per share.  During the three months ended June 30, 2014 and 2013, 506,513 and 585,621 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive, and during the six months ended June 30, 2014 and 2013, 530,961 and 618,904 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.
 
For the three months ended June 30, 2014 and 2013, distributions of $78,000 and $45,000, respectively, were made to holders of certain restricted common shares, $25,000 and $34,000, respectively, of which were charged against earnings. For the six months ended June 30, 2014 and 2013, distributions of $116,000 and $90,000, respectively, were made to holders of certain restricted common shares, $44,000 and $68,000, respectively, of which were charged against earnings. See Note 11 for information related to restricted common shares under the 2008 Plan.


14

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands, except per share data)
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
1,280

 
$
1,003

 
$
3,712

 
$
1,989

Less: Net income attributable to noncontrolling interests
 
(27
)
 
(33
)
 
(87
)
 
(70
)
Distributions paid on unvested restricted shares
 
(54
)
 
(11
)
 
(73
)
 
(22
)
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
1,199

 
$
959

 
$
3,552

 
$
1,897

 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average number of common shares - basic
 
22,235

 
16,891

 
22,030

 
16,855

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted shares
 
208

 
220

 
162

 
218

Weighted average number of common shares - dilutive
 
22,443

 
17,111

 
22,192

 
17,073

 
 
 
 
 
 
 
 
 
Earnings Per Share:
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.05

 
$
0.06

 
$
0.16

 
$
0.11

Diluted:
 
 
 
 
 
 
 
 
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.05

 
$
0.06

 
$
0.16

 
$
0.11


9. INCOME TAXES
 
Federal income taxes are not provided because we intend to and believe we qualify as a REIT under the provisions of the Internal Revenue Code (the “Code”) and because we have distributed and intend to continue to distribute all of our taxable income to our shareholders.  As a REIT, we must distribute at least 90% of our real estate investment trust taxable income to our shareholders and meet certain income sources and investment restriction requirements.  In addition, REITs are subject to a number of organizational and operational requirements.  If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.
 
Taxable income differs from net income for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation and rental revenue. 

We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (1% for us) to the profit margin, which generally will be determined for us as total revenue less a 30% standard deduction.  Although the Texas Margin Tax is not an income tax, FASB ASC 740, “Income Taxes” (“ASC 740”) applies to the Texas Margin Tax.  For the three months ended June 30, 2014 and 2013, we recognized approximately $42,000 and $64,000 in margin tax provision, respectively, and for the six months ended June 30, 2014 and 2013, we recognized approximately $109,000 and $124,000 in margin tax provision, respectively.

10.  EQUITY

Common Shares    

Under our declaration of trust, as amended, we have authority to issue up to 400,000,000 common shares of beneficial interest, $0.001 par value per share, and up to 50,000,000 preferred shares of beneficial interest, $0.001 par value per share.
  

15

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

Equity Offerings    

On October 8, 2013, we completed the sale of 4,000,000 common shares, $0.001 par value per shares, and on October 28, 2013, upon the underwriters' exercise of the over-allotment option, we completed the sale of 600,000 additional common shares, at a price to the public of $13.54 per share. Total net proceeds from the offering, including the over-allotment shares, and after deducting the underwriting discount and offering expenses, were approximately $59.7 million, which we contributed to the Operating Partnership in exchange for OP units. The Operating Partnership used the net proceeds from this offering for general corporate purposes, which included acquisitions of additional properties, the repayment of outstanding indebtedness, capital expenditures (including tenant improvements), the expansion, redevelopment and/or re-tenanting of properties in our portfolio, working capital and other general purposes.

On June 19, 2013, we entered into five equity distribution agreements for an at-the-market distribution program.  Pursuant to the terms and conditions of the agreements, we can issue and sell up to an aggregate of $50 million of our common shares. Actual sales will depend on a variety of factors to be determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and will be made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. We have no obligation to sell any of our common shares, and could at any time suspend offers under the agreements or terminate the agreements. During the three and six months ended June 30, 2014, we sold 377,983 common shares under the equity distribution program, with net proceeds to us of approximately $5.3 million. In connection with such sales, we paid compensation of $0.1 million to the sales agents. We had not sold any common shares under the equity distribution program as of June 30, 2013.

Operating Partnership Units 
Substantially all of our business is conducted through our Operating Partnership.  We are the sole general partner of the Operating Partnership.  As of June 30, 2014, we owned a 98.0% interest in the Operating Partnership.
 
Limited partners in the Operating Partnership holding OP units have the right to convert their OP units into cash or, at our option, common shares at a ratio of one OP unit for one common share.  Distributions to OP unit holders are paid at the same rate per unit as distributions per share to holders of Whitestone common shares.  As of June 30, 2014 and December 31, 2013, there were 23,029,349 and 22,384,970 OP units outstanding, respectively.  We owned 22,563,091 and 21,822,878 OP units as of June 30, 2014 and December 31, 2013, respectively. The balance of the OP units is owned by third parties, including certain trustees.  Our weighted average share ownership in the Operating Partnership was approximately 97.8% and 96.7% for the three months ended June 30, 2014 and 2013, respectively, and 97.7% and 96.5% for the six months ended June 30, 2014 and 2013, respectively. During the three months ended June 30, 2014 and 2013, 84,431 and 27,175 OP units, respectively, were redeemed for an equal number of common shares, and during the six months ended June 30, 2014 and 2013,
95,834 and 105,604 OP units, respectively, were redeemed for an equal number of common shares.

16

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

 Distributions
 
The following table summarizes the cash distributions paid or payable to holders of common shares and to holders of noncontrolling OP units during each quarter during 2013 and the six months ended June 30, 2014 (in thousands, except per share/unit data):

 
 
Common Shares
 
Noncontrolling OP Unit Holders
 
Total
Quarter Paid
 
Distributions Per Common Share
 
Total Amount Paid
 
Distributions Per OP Unit
 
Total Amount Paid
 
Total Amount Paid
2014
 
 
 
 
 
 
 
 
 
 
Second Quarter
 
$
0.2850

 
$
6,367

 
$
0.2850

 
$
152

 
$
6,519

First Quarter
 
0.2850

 
6,231

 
0.2850

 
158

 
6,389

Total
 
$
0.5700

 
$
12,598

 
$
0.5700

 
$
310

 
$
12,908

 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
5,790

 
$
0.2850

 
$
163

 
$
5,953

Third Quarter
 
0.2850

 
4,865

 
0.2850

 
165

 
5,030

Second Quarter
 
0.2850

 
4,832

 
0.2850

 
169

 
5,001

First Quarter
 
0.2850

 
4,807

 
0.2850

 
194

 
5,001

Total
 
$
1.1400

 
$
20,294

 
$
1.1400

 
$
691

 
$
20,985


11.  INCENTIVE SHARE PLAN
 
On July 29, 2008, our shareholders approved the 2008 Plan. On December 22, 2010, our board of trustees amended the 2008 Plan to allow for awards in or related to Class B common shares pursuant to the 2008 Plan. On June 27, 2012, our Class B common shares were redesignated as "common shares." The 2008 Plan, as amended, provides that awards may be made with respect to common shares of Whitestone or OP units, which may be converted into cash or, at our option, common shares of Whitestone. The maximum aggregate number of common shares that may be issued under the 2008 Plan is increased upon each issuance of common shares by Whitestone so that at any time the maximum number of shares that may be issued under the 2008 Plan shall equal 12.5% of the aggregate number of common shares of Whitestone and OP units issued and outstanding (other than shares and/or OP units issued to or held by Whitestone).

The Compensation Committee of our board of trustees administers the 2008 Plan, except with respect to awards to non-employee trustees, for which the 2008 Plan is administered by our board of trustees.  The Compensation Committee is authorized to grant share options, including both incentive share options and non-qualified share options, as well as share appreciation rights, either with or without a related option. The Compensation Committee is also authorized to grant restricted common shares, restricted common share units, performance awards and other share-based awards. 

On April 2, 2014, the terms of 633,704 awards for 51 of our employees which included time and performance-based restricted common shares and restricted common share units were modified to include time and performance-based vesting requirements. The modified time-based shares will vest annually in three equal installments. The modified performance-based restricted common shares and restricted common share units were modified to include performance-based vesting based on achievement of certain absolute financial goals, as well as one to two years of time-based vesting post achievement of financial goals. Continued employment is required through the applicable vesting date. Additionally, 2,049,116 restricted performance-based common share units were granted with the same vesting conditions as the modified performance-based grants described above. If the performance targets are not met prior to December 31, 2018, any unvested restricted common shares and restricted common units will be forfeited.

17

WHITESTONE REIT AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014
(Unaudited)

A summary of the share-based incentive plan activity as of and for the six months ended June 30, 2014 is as follows:
 
 
Shares
 
Weighted Average
Grant Date
Fair Value (1)
Non-vested at January 1, 2014
 
759,711

 
$
13.69

Granted
 
2,049,116

 
14.40

Modified to new agreements
 
(633,704
)
 
13.88

Modified from existing agreements
 
633,704

 
14.59

Vested
 
(119,794
)
 
12.73

Forfeited
 
(17,799
)
 
14.34

Non-vested at June 30, 2014
 
2,671,234

 
$
14.44

Available for grant at June 30, 2014
 
371,409

 
 

(1) 
The fair value of the common shares granted before trading of the common shares commenced on the NYSE MKT on August 26, 2010 were determined based on observable market transactions occurring near the date of the grants. The fair value of the common shares granted subsequent to August 26, 2010 was determined based on the fair value at the date of grant.

A summary of our non-vested and vested shares activity for the six months ended June 30, 2014 and years ended December 31, 2013, 2012 and 2011 is presented below:
 
 
Shares Granted
 
Shares Vested
 
 
Non-Vested Shares Issued
 
Weighted Average Grant-Date Fair Value
 
Vested Shares
 
Total Vest-Date Fair Value
 
 
 
 
 
 
 
 
(in thousands)
Six months ended June 30, 2014
 
2,049,116

 
$
14.40

 
(119,794
)
 
$
1,524

Year Ended December 31, 2013
 
328,005

 
15.43

 
(15,270
)
 
224

Year Ended December 31, 2012
 
99,700

 
13.03

 
(16,208
)
 
223

Year Ended December 31, 2011
 

 

 
(5,169
)
 

    
Total compensation recognized in earnings for share-based payments was $1,234,000 and $311,000 for the three months ended June 30, 2014 and 2013, respectively, and $1,607,000 and $667,000 for the six months ended June 30, 2014 and 2013, respectively.

Based on our current financial projections, we expect approximately 62% of the unvested awards to vest over the next 48 months. As of June 30, 2014, there was approximately $14.8 million in unrecognized compensation cost related to outstanding non-vested performance-based shares, which are expected to vest over a period of 48 months and approximately $1.0 million in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a period of approximately 33 months beginning on July 1, 2014.

We expect to record approximately $4.2 million in non-cash share-based compensation expense in 2014 and $13.4 million subsequent to 2014. The unrecognized share-based compensation cost is expected to vest over a weighted average period of 41 months. The dilutive impact of the performance-based shares will be included in the denominator of the earnings per share calculation beginning in the period that the performance conditions are expected to be met.

12. GRANTS TO TRUSTEES

On September 16, 2013, each of our five independent trustees was granted 1,500 common shares, which vested immediately. The 7,500 common shares granted to our five independent trustees had a grant date fair value of $14.52 per share. On January 31, 2014, three of our independent trustees elected to receive a total of 2,877 common shares with a grant date fair value of $13.62 in lieu of cash for board fees. The fair value of the shares granted were determined using quoted prices available on the date of grant.

13. SEGMENT INFORMATION

Historically, our management has not differentiated results of operations by property type or location and, therefore, does not present segment information.

14. REAL ESTATE

Property Acquisitions. On December 5, 2013, we acquired Market Street at DC Ranch, a property that meets our Community Centered Property strategy, for approximately $37.4 million in cash and net prorations. The 241,280 square foot property was 80% leased at the time of purchase and is located in Scottsdale, Arizona.

On October 17, 2013, we acquired a 2.50 acre parcel for $2.8 million in cash and net prorations. The parcel is located in Spring, Texas, a suburb of Houston, and is contiguous to our Corporate Park Woodland property. At the time of purchase, the parcel had 16,220 square feet and was 63% leased.

On October 7, 2013, we acquired Fountain Hills Plaza, a property that meets our Community Centered Property strategy, for approximately $20.6 million in cash and net prorations. The 111,289 square foot property was 87% leased at the time of purchase and is located in Fountain Hills, Arizona, a suburb of Phoenix.

On June 28, 2013, we acquired Anthem Marketplace, a property that meets our Community Centered Property strategy, for approximately $23.3 million in cash and net prorations. The 113,293 square foot property was 100% leased at the time of purchase and is located in Phoenix, Arizona. In the same purchase, we also acquired an adjacent development pad site of 0.83 acres.

On June 19, 2013, we acquired Mercado at Scottsdale Ranch, a property that meets our Community Centered Property strategy, for approximately $21.3 million, including the assumption of a $11.1 million non-recourse loan, a $0.9 million interest rate supplement and cash of $9.3 million. The 118,730 square foot property was 100% leased at the time of purchase and is located in Scottsdale, Arizona.

On March 28, 2013, we acquired Headquarters Village Shopping Center, a property that meets our Community Centered Property strategy, for approximately $25.7 million in cash and net prorations. The 89,134 square foot property was 100% leased at the time of purchase and is located in Plano, Texas.

15. SUBSEQUENT EVENTS

On July 1, 2014, we acquired Heritage Trace Plaza, a property that meets our Community Centered Property strategy, for approximately $20.1 million in cash and net prorations. The 70,431 square foot property was 98% leased at the time of purchase and is located in Fort Worth, Texas. Proceeds from the Facility of $20.0 million were used for the acquisition and our remaining borrowing capacity was $17.2 million, with an additional $50 million available upon the Operating Partnership's execution of the accordion option from the Facility, which accordion option is subject to customary closing conditions.

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Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion of our financial condition and results of operations in conjunction with our unaudited consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q (the “Report”), and the consolidated financial statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for the year ended December 31, 2013.  For more detailed information regarding the basis of presentation for the following information, you should read the notes to the unaudited consolidated financial statements included in this Report.

This Report contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters.  These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry.  Forward-looking statements are typically identified by the use of terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative of such terms and variations of these words and similar expressions, although not all forward-looking statements include these words.  These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.
     
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false.  You are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this Report.  We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.  Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:

the imposition of federal taxes if we fail to qualify as a REIT in any taxable year or forego an opportunity to ensure REIT status;
uncertainties related to the national economy, the real estate industry in general and in our specific markets;
legislative or regulatory changes, including changes to laws governing REITs;
adverse economic or real estate developments in Texas, Arizona or Illinois;
increases in interest rates and operating costs;
availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures;
decreases in rental rates or increases in vacancy rates;
litigation risks;
lease-up risks, including leasing risks arising from exclusivity and consent provisions in leases with significant tenants;
our inability to renew tenants or obtain new tenants upon the expiration of existing leases;
our inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws; and
the need to fund tenant improvements or other capital expenditures out of operating cash flow.
 
The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 2013, as previously filed with the Securities and Exchange Commission ("SEC") and of this Report below.
 
Overview

We are a fully integrated real estate company that owns and operates Community Centered Properties in culturally diverse markets in major metropolitan areas.  We define Community Centered Properties as visibly located properties in established or developing culturally diverse neighborhoods in our target markets.  Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.


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In October 2006, our current management team joined the Company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties.  We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants and medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.  We employ and develop a diverse group of associates who understand the needs of our multicultural communities and tenants.

We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership. We currently conduct substantially all of our operations and activities through the Operating Partnership. As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.

As of June 30, 2014, we owned and operated 60 commercial properties consisting of:

Operating Portfolio
33 retail properties containing approximately 2.8 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $329.1 million;
seven office properties containing approximately 0.6 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $42.3 million; and
11 office/flex properties containing approximately 1.2 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $37.8 million.
Redevelopment, New Acquisitions Portfolio
three retail properties containing approximately 0.4 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $59.9 million; and
six parcels of land held for future development having a total carrying value of $8.8 million.
As of June 30, 2014, we had an aggregate of 1,232 tenants.  We have a diversified tenant base with our largest tenant comprising only 1.9% of our annualized rental revenues for the six months ended June 30, 2014.  Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants.  Our leases generally include minimum monthly lease payments and tenant reimbursements for payment of taxes, insurance and maintenance.  We completed 215 new and renewal leases during the six months ended June 30, 2014, totaling 452,233 square feet and approximately $26.3 million in total lease value.  This compares to 158 new and renewal leases totaling 338,506 square feet and approximately $20.4 million in total lease value during the same period in 2013.

We employed 78 full-time employees as of June 30, 2014.  As an internally managed REIT, we bear our own expenses of operations, including the salaries, benefits and other compensation of our employees, office expenses, legal, accounting and investor relations expenses and other overhead costs.

How We Derive Our Revenue
 
Substantially all of our revenue is derived from rents received from leases at our properties. We had rental income and tenant reimbursements of approximately $17.7 million and $14.8 million for the three months ended June 30, 2014 and 2013, respectively, and $35.5 million and $28.7 million for the six months ended June 30, 2014 and 2013, respectively.


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Known Trends in Our Operations; Outlook for Future Results
 
Rental Income
 
We expect our rental income to increase year-over-year due to the addition of properties. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly acquired properties with vacant space, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Negative trends in one or more of these factors could adversely affect our rental income in future periods, although we expect modest continued improvement in the overall economy in our markets to provide slight increases in occupancy at certain of our properties.
 
Scheduled Lease Expirations
 
We tend to lease space to smaller businesses that desire shorter term leases. As of June 30, 2014, approximately 27% of our gross leasable area was subject to leases that expire prior to December 31, 2015.  Over the last two years, we have renewed leases covering approximately 74% of our expiring square footage as a result of lease maturities. We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While our early renewal program and other leasing and marketing efforts target these expiring leases, we hope to re-lease most of that space prior to expiration of the leases. In the markets in which we operate, we obtain and analyze market rental rates through review of third-party publications, which provide market and submarket rental rate data and through inquiry of property owners and property management companies as to rental rates being quoted at properties that are located in close proximity to our properties and we believe display similar physical attributes as our nearby properties. We use this data to negotiate leases with new tenants and renew leases with our existing tenants at rates we believe to be competitive in the markets for our individual properties. Due to the short term nature of our leases, and based upon our analysis of market rental rates, we believe that, in the aggregate, our current leases are at market rates. Market conditions, including new supply of properties, and macroeconomic conditions in our markets and nationally affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could adversely impact our renewal rate and/or the rental rates we are able to negotiate. We continue to monitor our tenants' operating performances as well as overall economic trends to evaluate any future negative impact on our renewal rates and rental rates, which could adversely affect our cash flow and ability to make distributions to our shareholders.
 
Acquisitions
 
We expect to actively seek acquisitions in the foreseeable future. We believe that over the next few years we will continue to have excellent opportunities to acquire quality properties at historically attractive prices. We have extensive relationships with community banks, attorneys, title companies and others in the real estate industry, which we believe enables us to take advantage of these market opportunities and maintain an active acquisition pipeline.
 
Property Acquisitions
 
We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered Properties strategy.  We define Community Centered Properties as visibly located properties in established or developing, culturally diverse neighborhoods in our target markets, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston.  We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants, medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.

On July 1, 2014, we acquired Heritage Trace Plaza, a property that meets our Community Centered Property strategy, for approximately $20.1 million in cash and net prorations. The 70,431 square foot property was 98% leased at the time of purchase and is located in Fort Worth, Texas.

On December 5, 2013, we acquired Market Street at DC Ranch, a property that meets our Community Centered Property strategy, for approximately $37.4 million in cash and net prorations. The 241,280 square foot property was 80% leased at the time of purchase and is located in Scottsdale, Arizona.


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On October 17, 2013, we acquired a 2.50 acre parcel for $2.8 million in cash and net prorations. The parcel is located in Spring, Texas, a suburb of Houston, and is contiguous to our Corporate Park Woodland property. At the time of purchase, the parcel had 16,220 square feet and was 63% leased.

On October 7, 2013, we acquired Fountain Hills Plaza, a property that meets our Community Centered Property strategy, for approximately $20.6 million in cash and net prorations. The 111,289 square foot property was 87% leased at the time of purchase and is located in Fountain Hills, Arizona, a suburb of Phoenix.

On June 28, 2013, we acquired Anthem Marketplace, a property that meets our Community Centered Property strategy, for approximately $23.3 million in cash and net prorations. The 113,293 square foot property was 100% leased at the time of purchase and is located in Phoenix, Arizona. In the same purchase, we also acquired an adjacent development pad site of 0.83 acres.

On June 19, 2013, we acquired Mercado at Scottsdale Ranch, a property that meets our Community Centered Property strategy, for approximately $21.3 million, including the assumption of a $11.1 million non-recourse loan, a $0.9 million interest rate supplement and cash of $9.3 million. The 118,730 square foot property was 100% leased at the time of purchase and is located in Scottsdale, Arizona.

On March 28, 2013, we acquired Headquarters Village Shopping Center, a property that meets our Community Centered Property strategy, for approximately $25.7 million in cash and net prorations. The 89,134 square foot property was 100% leased at the time of purchase and is located in Plano, Texas.

Critical Accounting Policies

In preparing the consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. Actual results may differ from these estimates.  A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2013, under "Management's Discussion and Analysis of Financial Condition and Results of Operations."  There have been no significant changes to these policies during the six months ended June 30, 2014.  For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 in our Annual Report on Form 10-K for the year ended December 31, 2013.


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Results of Operations

Comparison of the Three Months Ended June 30, 2014 and 2013
 
The following table provides a summary comparison of our results of operations for the three months ended June 30, 2014 and 2013 (dollars in thousands, except per share and OP unit amounts):
 
 
Three Months Ended June 30,
 
 
2014
 
2013
Number of properties owned and operated
 
60

 
55

Aggregate gross leasable area (sq. ft.)
 
4,967,509

 
4,597,541

Ending occupancy rate - operating portfolio(1)
 
86
%
 
87
%
Ending occupancy rate - all properties
 
86
%
 
86
%
 
 
 
 
 
Total property revenues
 
$
17,674

 
$
14,795

Total property expenses
 
6,393

 
5,360

Total other expenses
 
9,920

 
8,320

Provision for income taxes
 
57

 
72

Loss on disposal of assets
 
24

 
40

Net income
 
1,280

 
1,003

Less:  Net income attributable to noncontrolling interests
 
27

 
33

Net income attributable to Whitestone REIT
 
$
1,253

 
$
970

 
 
 
 
 
Funds from operations core (2)
 
$
6,647

 
$
4,937

Property net operating income (3)
 
11,281

 
9,435

Distributions paid on common shares and OP units
 
6,519

 
5,001

Distributions per common share and OP unit
 
$
0.2850

 
$
0.2850

Distributions paid as a percentage of funds from operations core
 
98
%
 
101
%
(1)  
Excludes (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redevelopment or re-tenanting.
(2)  
For a reconciliation of funds from operations core to net income, see "Funds From Operations Core" below.
(3)  
For a reconciliation of property net operating income to net income, see "Property Net Operating Income" below.

Property revenues. We had rental income and tenant reimbursements of approximately $17,674,000 for the three months ended June 30, 2014 as compared to $14,795,000 for the three months ended June 30, 2013, an increase of $2,879,000, or 19%. The three months ended June 30, 2014 included $2,594,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired since the beginning of the period being compared. For purposes of comparing the three months ended June 30, 2014 to the three months ended June 30, 2013, New Stores include properties acquired between April 1, 2013 and June 30, 2014. Same Store revenues increased $285,000 for the three months ended June 30, 2014 as compared to the same period in the prior year. We define "Same Stores" as properties that have been owned since the beginning of the period being compared. For purposes of comparing the three months ended June 30, 2014 to the three months ended June 30, 2013, Same Stores include properties currently owned that were acquired before April 1, 2013. Same Store average occupancy increased from 84.4% for the three months ended June 30, 2013 to 85.4% for the three months ended June 30, 2014, increasing Same Store revenue $103,000. The Same Store average revenue per leased square foot increased $0.11 for the three months ended June 30, 2014 to $16.08 per leased square foot as compared to the average revenue per leased square foot of $15.97 for the three months ended June 30, 2013, resulting in an increase of Same Store revenues of $182,000.


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Property expenses.  Our property expenses were approximately $6,393,000 for the three months ended June 30, 2014 as compared to $5,360,000 for the three months ended June 30, 2013, an increase of $1,033,000, or 19%.  The primary components of total property expenses are detailed in the table below (in thousands, except percentages):
 
 
Three Months Ended June 30,
 
 
 
 
Overall Property Expenses
 
2014
 
2013
 
Change
 
% Change
Real estate taxes
 
$
2,251

 
$
2,012

 
$
239

 
12
 %
Utilities
 
1,113

 
864

 
249

 
29
 %
Contract services
 
1,098

 
887

 
211

 
24
 %
Repairs and maintenance
 
554

 
469

 
85

 
18
 %
Bad debt
 
663

 
398

 
265

 
67
 %
Labor and other
 
714

 
730

 
(16
)
 
(2
)%
Total property expenses
 
$
6,393

 
$
5,360

 
$
1,033

 
19
 %

 
 
Three Months Ended June 30,
 
 
 
 
Same Store Property Expenses
 
2014
 
2013
 
Change
 
% Change
Real estate taxes
 
$
1,975

 
$
1,997

 
$
(22
)
 
(1
)%
Utilities
 
959

 
862

 
97

 
11
 %
Contract services
 
961

 
883

 
78

 
9
 %
Repairs and maintenance
 
404

 
469

 
(65
)
 
(14
)%
Bad debt
 
629

 
392

 
237

 
60
 %
Labor and other
 
669

 
728

 
(59
)
 
(8
)%
Total property expenses
 
$
5,597

 
$
5,331

 
$
266

 
5
 %

 
 
Three Months Ended June 30,
 
 
 
 
New Store Property Expenses
 
2014